Personal Services Businesses and Government IT Consultants

The Canada Revenue Agency (“CRA”) is in the process of auditing and reassessing IT contractors that provide services under long term contracts to various government departments.  The CRA’s position is that these contractors were employees for tax purposes and any corporations were personal service businesses (the “Rulings”).  If the Rulings stand, the Rulings will impact the IT contractors as follows.  First, the CRA will remove the corporate tax rate reductions on income.  Second, the CRA will deny the small business deduction.  Third, the CRA will deny the expenses claimed.  Last, the CRA may impose gross negligence penalties.   

We are representing a number of IT contractors who have been reassessed and have objected to the Rulings.  It appears that the CRA are attempting to group these objections and place these objections on hold.  In the interim, the CRA has selected a few of the objections and is proceeding to the Tax Court of Canada with these hand-picked objections.  We believe that – if the CRA are successful in the Tax Court – the CRA will attempt to use these hand-picked cases to persuade the other IT contractors to abandon their objections in whole or in part and consent to the Rulings.  If the CRA is not successful in Tax Court, the CRA may appeal the Tax Court’s decision or take the position that these are fact-based cases and, therefore, the Tax Court’s decision is not binding on the outstanding objections.

We believe that the determination as to whether a worker is an employee, incorporated employee or independent contractor is a fact-driven determination.  Although some cases are similar, they are not the same.   Each case is different and an independent decision-maker should consider the unique circumstances of each case in order to make the correct determination in fact and law.  In these circumstances, we believe that the CRA’s attempt to group the IT consultants’ objections and bind the IT consultants is not appropriate.  In addition, the CRA’s strategy is not in the IT consultants’ best interest.

We believe that every case would benefit from an independent analysis of the IT consultants unique facts and a review of the potential strategies.  This way, the IT consultant can determine whether they should wait for the conclusion of the CRA’s test cases or whether the IT consultant should forgo the objection stage (and the CRA’s attempt to hold the objection) and appeal the matter directly to the Tax Court in accordance with subsection 169(1) of the Income Tax Act. 

We welcome the opportunity to meet with other IT consultants to discuss their file and recommend a custom strategy.  We believe that all IT consultants interested in defending their filing positions will benefit from the application of communal knowledge to each unique case.  If you are interested, please contact Kristina Anderson at 416.218.5263 ext 112 or info@atxlaw.ca to schedule a consultation. 

SR&ED & CRA Notices of Objection

We have experience representing SR&ED claimants at the objection and appeal stages.  At times, we have questioned the CRA’s level of service and processes surrounding SR&ED objections.  Today, the CRA published its press release entitled “CRA – Notices of Objection for SR&ED eligibility claims – Improved review process“ announcing that it has implemented new SR&ED objection processes.  The CRA announced the following new features.

Additional staff with a broad range of science and engineering expertise has been hired to provide a more specialized review of the issues under objection, and to provide for more timely reviews.

The reviews are more in-depth, with a greater focus on addressing the SR&ED eligibility issues raised by the claimants in their Notices of Objection.

The reviews have been expanded to provide for contact between the Agency’s SR&ED Notice of Objection advisors and the SR&ED claimants. However, it is important to note that these reviews are desk reviews and not second on-site SR&ED technical reviews.

We believe that the objection stage is a crucial stage that provides SR&ED claimants the opportunity to better understand and probe the CRA’s position, to resolve an SR&ED dispute early and - if resolution is not possible - to implement the proper factual, legal and strategic foundation for the appeal stage.  We hope that the CRA’s new processes, in fact, lead to a more transparent, efficient and independent SR&ED objection process.  

Tax Advisors & Accountants Third-Party Penalties: Civil or Criminal?

Prior to 1999, the Minister of National Revenue and Canada Revenue Agency (hereinafter jointly referred to as the “CRA”) had two legislative tools to severely punish taxpayers, advisors, planners, promoters and preparers i.e., subsection 163(2) and section 239 of the Income Tax Act (“ITA”). 

Subsection 163(2) of the ITA provides the CRA can assess 50 per cent civil gross negligence tax penalties against a taxpayer who knowingly, or under circumstances amounting to gross negligence, made a false statement or omission in his tax return (the “gross negligence penalty”).  In these cases, CRA bears a heavy onus of proof to establish, on a balance of probabilities, that the taxpayer’s conduct was reprehensible (bordering on criminal behavior) or reckless to justify the imposition of the gross negligence penalty against the taxpayer. 

Section 239 of the ITA provides that the CRA can lay a tax evasion charge in the Criminal Court against the taxpayer, or any other person who conspired, to attempt to willfully evade the payment of tax.  In these cases, CRA bears the highest onus of proof, beyond a reasonable doubt, to establish that the taxpayer or the conspirator attempted to willfully evade the payment of tax.  This section enables to the CRA to lay tax evasion charges against conspirators such as tax promoters, planners and preparers who encourage or help facilitate tax evasion.  However, the high onus of proof in these cases makes it difficult for the CRA to secure convictions. 

In reviewing the gross negligence penalty and section 239 of the ITA, Parliament decided to expand the legislation to enable the CRA to punish tax advisors, promoters, planners and preparers but to avoid the difficulties of establishing proof beyond a reasonable doubt in the criminal context.  In short, Parliament intended to create a civil penalty similar to the gross negligence penalty that would enable the CRA to punish third-parties who advised other taxpayers to submit tax returns that contravened the ITA and third-parties that prepared tax returns that contravened the ITA.  This way, the CRA could punish conspirators using a lower standard of proof which would result in greater success in securing the punishment. 

As a result, Parliament enacted subsection 163.2(2) of the ITA to punish tax advisors and subsection 163.2(4) to punish tax preparers (jointly referred to as the “Third-Party Penalty”).  Although the courts have held on several occasions that CRA Information Circulars are not the law, the CRA has published Information Circular 01-1 entitled Third-Party Civil Penalties outlining its position related to the Third-Party Penalty.  Generally speaking, the quantum of these penalties is the sum of the amount of tax that the advisor or preparer attempted to help his client(s) evade and the limit, if any, to the Third-Party Penalty is quite high.   In fact, it appears that the quantum of the Third-Party Penalty could exceed a penalty imposed under section 239 of the ITA.

The CRA reports that - since section 163.2 was enacted - it has completed its review of 121 potential Third-Party Penalties cases.  It has imposed Third-Party Penalties in 71 cases totaling $79 million.  

Our firm, along with other tax practitioners and commentators, have long criticized the Third-Party Penalty on the bases that the nature of the matter is a criminal proceeding disguised as a civil penalty (i.e., it seeks to remedy a societal problem not a private matter) and that the punishment is a true penal consequence (i.e., the quantum of the Third-Party Penalty is so high that it is a penal punishment).  If these criticisms are correct, the Third-Party Penalty would engage the protection of section 11 of the Canadian Charter of Rights and Freedoms (“Charter”) to guarantee the third-party additional substantive and procedural rights including the right to be presumed innocent.  In addition, the application of the Charter and the right to be presumed innocent would raise the CRA’s burden of proof to proof beyond a reasonable doubt.

Guindon v. Her Majesty the Queen (“Guindon”).

In Guindon, the Tax Court had its first opportunity to consider whether the Third-Party Penalties were criminal in nature and applied a true penal consequence.  Ms. Guindon was a lawyer and a president of a charity that was involved in a charitable donation tax program (the “Tax Shelter”).  Although Ms. Guindon was not a tax lawyer and she did not fully review the underlying documents, she provided a legal opinion to support the Tax Shelter.  In addition, she signed tax receipts related to the Tax Shelter.    The CRA established that the Tax Shelter did not comply with the ITA and imposed a $546,747 Third-Party Penalty.  Ms. Guindon appealed the assessment in the Tax Court.

The Tax Court allowed Ms. Guindon’s appeal on the basis that the Third-Party Penalty created a criminal offence.  The Tax Court noted that the Third-Party Penalty does not require that a taxpayer relied on the advisor’s false statement only that the taxpayer could have relied on the false statement.  The Tax Court held that this indicates that the Third-Party Penalty acts as a public deterrent as oppose to a private disciplinary matter and, therefore, the nature of the matter is criminal.

Section 163.2 applies to third parties who, by making a false statement, could have led another person to use that statement for a purpose of the Act. The Third-Partyis not the person considered to have acted upon the false statement and, as mentioned earlier, section 163.2 of the Act takes aim even at situations where the false statement has not been acted upon by another person. For these reasons, the argument that section 163.2 prescribed a civil penalty as part of a regulatory scheme designed to ensure compliance with the Act is unpersuasive.

Second, the Tax Court held that the Third-Party Penalty constitutes a true penal consequence on the basis that the potential quantum of the penalty is so high that it appears to be an attempt to cure a societal wrong as oppose to a private disciplinary action related to a limited activity. 

In the case at bar, the Appellant was assessed a penalty in the amount of $546,747. This amount was calculated by adding up the amounts of the penalties under subsection 163(2) of the Act to which each of the 134 other donors would have been liable. The penalty under subsection 163.2(5) thus has the potential of increasing ad infinitum depending on the number of “other persons” involved. As the Appellant submitted, where the penalty is unlimited and is imposed on a Third -Party, it seems evident that its purpose is to redress a wrong done to society and consequently ceases to be a purely administrative matter or one of internal discipline.

Post-Guindon.

The Tax Court’s decision in Guindon undermines the CRA’s ability to impose the Third-Party Penalty and we believe that the decision is correct in law.  However, on October 31, 2012, the CRA filed its notice of appeal in the Federal Court of Appeal to Guindon.   

The CRA reports that 64 Third-Party Penalty cases are ongoing.  We represent an accountant in a Third-Party Penalty dispute at the objection stage.  The CRA has advised that it will hold all Third-Party Penalty objections in abeyance pending the resolution of Guindon.  We are watching Guindon and its impact closely and we will provide readers with another update as this matter develops.

Canada Revenue Agency (finally) warns Canadians about (detax) tax protester schemes

The Canada Revenue Agency (“CRA”) has assessed a number of taxpayers who have participated in the detax schemes.  In addition, the CRA has imposed 50% subsection 163(2) gross negligence penalties.  We think that - in many cases - the imposition of the subsection 163(2) gross negligence penalties is wrong in fact and law.  

We are in the process of representing taxpayers to dispute the correctness of the subsection 163(2) gross negligence penalties.  The detax “interpretation of the law” has been promoted for some time.  CRA has finally issued a press release warning taxpayers about detax and other types of tax protester schemes.  We are not sure what took so long.  

The interesting sections of the CRA’s press release, along with our comments, are as follows.

The CRA cautions all Canadians to be aware of individuals who try to convince them to not pay their taxes.

Taxpayers should be aware that tax protestors who promote intentional tax evasion are seeking a personal financial benefit at the expense of the taxpayer and of all Canadians. 

In our experience, taxpayers who participated in the detax scheme were persuaded that the scheme was legal and not contrary to the law.  It is not that the detax promoters persuaded these taxpayers that they should willfully evade tax or that the tax legislation was unjust.  Instead, the detax promoters  persuaded these taxpayers that the law allows for a refund of tax paid.

Canada has one of the highest rates of compliance in the world. However, individuals who try to evade or avoid taxes by participating in tax evasion schemes will be detected and addressed accordingly. That means you will lose the high fees you paid up front for the bad advice you’ve received from the promoter, and once your tax return is processed  the CRA will reassess income tax and interest, and charge penalties. In some cases, you could be prosecuted for tax evasion.

As discussed, the CRA is routinely imposing 50% gross negligence penalties.  It appears that - at this time - the CRA is not deleting the penalties at the objection stage.  In order to dispute the penalty, taxpayers will likely need to retain a tax lawyer and appeal the penalty in the Tax Court of Canada.    

If you have doubts about certain tax arrangements, you should get advice from an independent tax professional, someone who is not connected to the scheme or promoter. If it sounds too good to be true, it probably is.

It is not advisable or appropriate for taxpayers who participated in the detax scheme to obtain advice from the tax promoters, accounting professionals involved in the detax scheme or the CRA.  We believe that all of these parties have a vested interest in the outcome and, therefore, taxpayers will not receive independent information and advice.  

We recommend that taxpayers call our firm to obtain independent advice from a tax lawyer and discuss their options.  

The CRA cautions businesses on Electronic Sales Suppression software (Zappers)

We have published various tax law blog entries related to the Canada Revenue Agency’s audit of restaurants and electronic sales suppression software (commonly referred to as “Zapper” software).  The CRA has published its press release cautioning businesses to avoid Zapper software.  The CRA invites businesses who use Zapper software to disclose suppressed income under the Voluntary Disclosures Program to avoid criminal prosecution for tax evasion, 50% gross negligence penalties and reduce interest.  In addition, the press release encourages customers to report businesses using Zapper software to the CRA.

The CRA’s press release is reproduced below.

The Canada Revenue Agency (CRA) is aware that electronic sales suppression software (often referred to as “Zapper” software) is currently being marketed and sold to some Canadian businesses. Electronic sales suppression software is designed to work with point-of-sale systems and electronic cash registers. It can be used to select and delete cash sales from computer records in order to evade federal and provincial taxes. In some cases identified by the CRA, businesses have collected taxes from patrons, suppressed sales records using this software, and not sent the taxes to the CRA as required by law.

While Canada has one of the highest rates of compliance in the world, the illegal use of Zapper software is a problem that the CRA is actively addressing. The CRA is increasing its efforts to identify those who develop, sell, or use electronic sales suppression software for illegal purposes. Responsible business owners know that hiding income to evade taxes is against the law. Using this software for illegal purposes is not worth the risk.

What are the consequences for businesses?

Businesses that have used electronic sales suppression software to underreport their revenues will have to pay the taxes they did not report, plus interest and penalties. The owners of these businesses could also face criminal prosecution leading to court-imposed fines, and possibly even jail time. For more information on convictions, go towww.cra.gc.ca/convictions.

What can consumers do?

Although customers may not notice if a business appears to be using electronic sales suppression software, they can do their part to ensure tax compliance by always requesting a copy of their receipt. This may help discourage some businesses from deleting transactions. If customers become aware of any business using such software, they can report suspected tax evasion over the Internet or by contacting the Informant Leads Centre. Their identity will not be disclosed. They may also provide information anonymously by going towww.cra-arc.gc.ca/gncy/nvstgtns/lds/menu-eng.html

Who cares if a business doesn’t report all its income?

The CRA is committed to administering Canadian tax laws in a fair and equitable manner. Businesses that evade taxes are placing an unfair burden on the individuals and other businesses that accurately report their income and pay the taxes they owe. Not properly following tax laws also undermines competitiveness in the small business market. Those who avoid paying taxes are taking money that is needed for important investments in schools, hospitals, and other vital government services.

As a business, what can I do if I want to come forward?

If you have been using electronic sales suppression software for illegal purposes and want to come forward, you can do so through the CRA’s Voluntary Disclosures Program. If you make a full disclosure before any compliance action or criminal investigation is started, you may only have to pay the taxes owing plus interest, and you will not face penalties or prosecution in the courts. For more information, go towww.cra.gc.ca/voluntarydisclosures.

FCA Clarifies Burden of Proof in Tax Cases & ATX Law in the News

In McMillian v. Her Majesty the Queen, the Federal Court of Appeal clarified the burden of proof in tax cases.  We believed the decision was important and, in August 2012, we posted a blog article about the FCA’s decision.  Recently, The Bottom Line (Canada’s Accounting and Finance Professionals newspaper) published an article on McMillian and asked for our reaction.  We are flattered by the author’s decision to include our interpretation in the article entitled Court affirms burden of proof on taxpayer.  

Tax Quote of the Day: Canada Revenue Agency Information Circulars and Interpretation Bulletins

It is trite law that the Canada Revenue Agency (“CRA”) Information Circulars and Interpretation Bulletins do not have the force of law.  CRA Information Circulars and Interpretation Bulletins are simply the CRA’s interpretation of the Income Tax Act, Excise Tax Act and other tax legislation.  Unsurprisingly, the CRA’s interpretation of the law is often rooted in its own self-interest (i.e., to collect tax).  

In some cases, these publications help taxpayers and their advisers.  In other cases, CRA’s interpretation of the law is wrong and these publications may have a cooling effect on tax litigation.  In Northwest Hydraulic Consultants Ltd. v. Her Majesty the Queen, Chief Justice Bowman addressed this tension along with the weight that the Tax Court ascribe to the CRA’s published interpretations. 

The second preliminary observation that should be made is the use of Information Circular 86-4R3 which sets out criteria to be applied in determining whether an activity qualifies as SRED. In general I am reluctant to rely too heavily on interpretation bulletins and information circulars in determining contested issues under the Income Tax Act.  The reason for this is that in any litigious situation it seems somewhat unfair for an independent arbiter to place much weight on the rules of the game devised by one of the players.  I recognize that frequently interpretation bulletins and information circulars set out administrative interpretations and practices that are beneficial to the taxpayer and I am reluctant to do anything that would cast doubt on those interpretations and practices. [underlining added]

Tax Court Proposals & ATX Law in the News

We have written several postings related to the proposed changes in the Tax Court Act and Tax Court Rules.  To review, the proposed changes seek to increase the Tax Court Informal Procedure Limits (i.e., monetary increase), allow the Tax Court to dispose of issues raised in an appeal separately and allow the Tax Court to determine questions (i.e., pro tanto judgments) and bind multiple taxpayers with the same issue (i.e., common questions).

In June 2012, the Bottom Line asked me to provide my thoughts on the proposed legislation.  I repeated my caution that - if implemented as drafted - the proposed legislation would cause taxpayers and the Tax Court to suffer from some unintended consequences and that the proposed amendments should be reformulated.  ”The proposals are a good starting point.  However, the changes need to be carefully considered.”  The Bottom Line published its article entitled: Tax court proposals get mixed reception.

Following my contributions to the Ontario Bar Association submissions, the Bottom Line article and the Department of Finance’s (“Finance”) release of the draft legislation, I was asked to participate in a joint response to respond to the draft legislation.  I accepted on the basis that I believed that it was important that the Canadian Bar Association Tax Executive and Tax Court Bench & Bar Committee provide its position to Finance.  

In addition, I was very disappointed that Finance did not implement any of the suggested changes to the proposed legislation.  It is submitted that the pace that Finance is pushing through this important draft legislation is - uncharacteristically - quick.  Moreover, it is odd that Finance did not implement any of the responses or suggested changes to the draft legislation.

In any event, I am happy to have had the opportunity to work with the Canadian Bar Association’s Tax Executive and the Tax Court Bench and Bar Committee to respond to the Department’s draft legislation and reiterate our concern that the proposed changes may have negative effects and that Finance should amend the draft legislation.  

We keep working towards change and we will provide another update as soon as Finance provides its response.

Tax Quote of the Day: Taxpayer Burden of Proof in Tax Cases

In McMillan v. Her Majesty the Queen, the Federal Court of Appeal confirmed the principles which govern the burden of proof in tax cases.  The FCA confirmed that the law is unchanged.  In order to successfully defeat a Canada Revenue Agency reassessment, a taxpayer must displace or demolish the CRA’s assumptions that form the bases of the reassessment.  A taxpayer may displace or demolish the CRA’s assumptions if he makes a prima facie case.

Before concluding these reasons, we note that the appellant did not raise in her memorandum of fact and law any issue with respect to the Judge’s statement at paragraph 19 of the reasons, and repeated at paragraph 21, that the appellant “has the initial onus of proving on a balance of probabilities (i.e. that it is more likely than not), that any of the assumptions that were made by the Minister in assessing (or reassessing) the Appellant with which the Appellant does not agree, are not correct.” In our respectful view, it is settled law that the initial onus on an appellant taxpayer is to “demolish” the Minister’s assumptions in the assessment. This initial onus of “demolishing” the Minister’s assumptions is met where the taxpayer makes out at least a prima facie case. Once the taxpayer shows a prima facie case, the burden is on the Minister to prove, on a balance of probabilities, that the assumptions were correct (Hickman Motors Ltd. v. Canada,1997 CanLII 357 (SCC), [1997] 2 S.C.R. 336 at paragraphs 92 to 94; House v. Canada, 2011 FCA 234 (CanLII), 2011 FCA 234, 422 N.R. 144 at paragraph 30).

We encourage readers who are interested in achieving a better understanding of the burden of proof in tax cases to review the Supreme Court of Canada’s decision in Hickman Motors Ltd. v. Canada.  In particular, paragraphs 92 to 95 of the SCC’s reasons for judgement include the following statements:

[the taxpayer’s] initial onus of “demolishing” the Minister’s exact assumptions is met where the appellant makes out at least a prima facie case; 

[w]here the Minister’s assumptions have been “demolished” by the appellant, “the onus … shifts to the Minister to rebut the prima facie case” made out by the  appellant and to prove the assumptions;

[t]he law is settled that unchallenged and uncontradicted evidence “demolishes” the Minister’s assumptions;

[w]here the burden has shifted to the Minister, and the Minister adduces no evidence whatsoever, the taxpayer is entitled to succeed; and 

even if the evidence contained “gaps in logic, chronology, and substance”, the taxpayer’s appeal [will be] allowed [if] Minister fail[s]to present any evidence as to the source of income.