TaxMatters@EY – March 2011

You’ll also find helpful 2011 and comparative 2010 personal tax planning tools:

• An RRSP savings calculator showing the tax saving from your contribution
• Personal tax rates and credits, by province and territory, for all income levels

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• Combined federal–provincial corporate income tax rates for small business rate income, manufacturing and processing income, and general rate income.
• Provincial corporate income tax rates for small business rate income, manufacturing and processing income, and general rate income.
• Corporate income tax rates for investment income earned by Canadian-controlled private corporations (CCPCs) and other corporations.

You’ll find these useful resources — and our latest perspectives, thought leadership, Tax Alerts and much more — at ey.com/ca/Tax.

Fred O’Riordan

Many of the tax commissioners we’ve interviewed over the past 18 months or so have expressed the view that company boards and their audit committees should have firmer oversight of tax issues. Is this a view to which you subscribe?

Linda Lizotte-MacPherson

Yes, I agree that oversight of tax issues needs to occur at the boardroom level. How a company manages tax risk can affect its financial performance and reputation, and CEOs and boards of large businesses are increasingly considering tax risk management as part of their overall corporate governance.

At the CRA, we believe that a sustainable tax system is one where taxpayers appreciate that paying tax enables them to enjoy all the rights that accompany being a Canadian resident or business. We are seeing a growing movement to include paying tax as a key element of responsible citizenship, at both the individual and corporate levels. A number of large corporations, including some in the financial and energy sectors, are now detailing the amount of taxes paid in their annual corporate social responsibility reports. Some of these reports make the connection between paying taxes and the programs and services that are funded as a result.

This certainly is a trend worth watching, and one that to me, as Commissioner of the CRA, is very encouraging. From our perspective, increased transparency on the part of taxpayers helps us administer Canada’s tax laws with the least compliance burden for taxpayers and the most effective use of our resources.

We plan to explore opportunities for consultation with the business and academic communities regarding the potential for enhanced dialogue and cooperative work to raise awareness. One of the things we’d like to do is work with institutes and academia that provide training regarding board roles, risk management and corporate social responsibilities, to ensure tax risk is part of their curriculum.

This isn’t just about “being seen to do the right thing.” Establishing good corporate governance principles for tax matters, and openly and frankly sharing information with CRA, [are] effective means to reduce the costs of compliance with our tax laws. For example, disputes over tax audit issues can be minimized by the establishment of clear corporate governance frameworks that ensure all tax risks are properly identified and addressed on a timely basis.

Tax administrations have a vital role to play in helping corporate boards in relation to their responsibilities for tax strategies and material outcomes. I think there is merit to engaging in direct dialogue on this topic with CEOs and boards, given the significant and material risks inherent to tax.

These are the top five questions your audit committee should consider:

• How is management keeping current on tax issues and the potential for changes to its tax policy?
• Does the company have adequate, global resources to fully address these changes?
• Does the company have programs in place to monitor changes to tax policies and compliance?
• Does the company understand how these changes might affect financial reporting and its effective tax rate?
• Are the tax disclosures included in the company’s annual financial statements comprehensive and understandable?

• If an employee is reimbursed for business use of a vehicle, he or she can receive a tax-free allowance based solely on distance travelled.
• If a business owns a vehicle and makes it available to an employee or a shareholder, the extent of their personal use, both absolute and in proportion to business use, impacts the taxable benefit. If the taxpayer can support a claim of 100% business use, no taxable benefit applies.
• Vans, pickup trucks and similar vehicles are exempt from the deductibility restrictions normally applicable to automobiles if their use for transport of goods, equipment and/or passengers in the year of acquisition meets relevant benchmarks.
• The self-employed, and employees required to incur vehicle expenses in the course of their employment, pro rate their automobile costs between non-deductible personal use and deductible income-generating use based on the distance travelled for each purpose.

Similar issues apply for GST/HST purposes in determining the input tax credits available to registrants and the rebate available to employees and partners.

The CRA has for many years required logbooks of all business and personal driving to support vehicle usage. Many employers have been surprised to learn that the CRA considers it to be their responsibility to ensure employees are maintaining appropriate logbooks for company cars in their control.

Based on comments and recommendations from the Canadian Federation of Independent Business, the federal government identified the requirement to maintain a logbook as the most burdensome aspect of the motor vehicle provisions. In the 2008 federal budget, the government included a commitment to review this issue and develop a less onerous system for substantiating the allocation of vehicle usage between business and personal driving.

Last summer, the CRA announced that “Claims for a very low amount of business use do not require extensive records to demonstrate business travel. As the percentage of business use and the related expense claims increase, more documentation…is expected to be available.”

While noting that many types of records might support business use of a vehicle, including appointment diaries or logs of service calls, the CRA also notes that “individuals will be responsible for providing sufficient evidence to demonstrate the accuracy of their claims for business distances driven throughout the year.”

The CRA’s new policy is to afford considerable weight to a logbook maintained for a sample period, provided all of the following criteria are met:

• A logbook is maintained for a full 12-month period (the “base year”). This need not be a calendar year.
• In each subsequent year, a logbook is maintained for a sample period of at least one continuous three-month period in each subsequent year (the “sample year period”).
• The total distance and the business use of the vehicle during the sample year period must be within 10 percentage points of the corresponding figures for the same period in the base year.
• The resulting calculation of annual business use for each subsequent year cannot vary from the base year by more than ten percentage points.

Provided these criteria are met, business use of the vehicle is calculated by the following formula:

sample year period % ÷ base year period % x base year annual % = annual business use

For example, assume a logbook maintained for 1 July 2009 to 30 June 2010 reflects business use of 75%, and business use for the period 1 January to 31 March 2010 reflects 72% business usage. A logbook is maintained for 1 January to 31 March 2011, and reflects 70% business usage. Total mileage is within 10% of the January–March 2010 period. The formula would then compute business usage for the fiscal year including 1 January to 31 March 2011 as 70% ÷ 72% x 75% = 72.917%. The CRA indicates it would accept this “in the absence of contradictory evidence.”

Given the requirement that the sample log book not deviate by more than 10% from the same period in the base year, it would be desirable to maintain the sample log book for the first three months of every year, as evidence of the full year’s driving will be required if the results deviate by more than 10%.

For example, if the log book maintained from 1 January to 31 March 2011 reflected 61% business use, a drop of 11 percentage points, this would not meet the CRA’s criteria for extrapolating the full year’s business use from the sample period. Obviously, it would be too late to maintain a logbook for the period from 1 July to 31 December 2010, so an individual or business with a 30 June 2011 fiscal year end could easily be unable to support its business driving claims.

While the CRA’s new requirements are certainly less onerous than maintaining a logbook throughout the year, it seems questionable whether many businesses or individuals will see a significant reduction in their paper burden.

As the CRA’s position is fairly new, it remains uncertain how open they will be to alternative forms of support for business driving if their new procedure is not adhered to. It seems likely that disputes between taxpayers and the tax authorities over vehicle usage will continue in the future.

Your Ernst & Young advisor can help you review the documentation procedures for your vehicle usage so that you have appropriate support in the event of a CRA enquiry. If your vehicle claims are at issue with the CRA, we can help you negotiate a reasonable settlement.

Statutory provisions

Subsection 323(1) of the ETA reads as follows:

In the event that a corporation fails to remit GST/HST owing, directors may face the uncomfortable question as to whether they exercised appropriate care to prevent the failure to remit the tax. If it is determined that a director failed to meet the standard of care, the director may be held personally liable for any amounts owing. The relevant subsection in respect of due diligence is found in subsection 323(3) of the ETA, which reads as follows:

Observations

In interpreting the standard of care required under subsection 323(1), the courts have considered a number of factors. A primary factor is whether the director has been involved in the day-to-day operations of the business. If the director is involved in the daily management of the company and influences the conduct of its business affairs, then the director would be considered to be an inside director. Because a higher standard of care would be expected of an inside director, such individuals would have a harder time successfully arguing that they exercised due diligence to prevent the failure to remit the tax.

On the other hand, a director who has a lesser role in the daily operations of a business would be considered to be an outside director, and the standard of care to be applied is less stringent.

In reviewing four relatively recent Tax Court of Canada cases that considered the due diligence defence issue, the courts found in favour of the taxpayers in the two cases where they were considered outside directors, and ruled against the taxpayers in the two cases where they were considered to be inside directors.

That is not to say that outside directors bear no risk or obligation under subsection 323(1). Indeed, to the extent that an outside director obtains information indicating that there may be problems with remittances, the outside director has a duty to act on that information.

In addition to depending on the director’s role with the business, the standard of care applicable to a particular director will depend on the director’s business knowledge and financial experience. The greater a director’s knowledge and experience, the higher the standard that’s expected.

Another factor considered in determining the appropriate standard of care of a director is the size and complexity of the business. In a large and complex business, a director is more likely to have specialists responsible for GST/HST filings and is less likely to be personally involved.

It should be noted that an assessment under section 323 of the ETA against a director of a corporation cannot be made more than two years after the person last ceased to be a director of the corporation.

In summary, directors should be cognizant of the potential personal exposure that may arise under section 323 of the ETA if their company fails to remit GST/HST that is due, and should ensure that they are meeting the appropriate standard of care and diligence as required under subsection 323(3).

The facts

In December 1992, the taxpayer and her son each rolled into a newly formed partnership a 50% undivided interest in certain real properties. As consideration, the partnership issued 1.252 million redeemable Class A partnership units to each of the taxpayer and her son, and assumed certain liabilities associated with the properties.

In January 1993, the partnership issued 100 Class C units to the son’s family trust for cash consideration of $100. The purpose of the structure was to effect an estate freeze under which future growth in the transferred properties would accrue to the trust beneficiaries.

The partnership had profits of approximately $342,000 in 1994; $108,000 was allocated to each of the taxpayer and her son on their Class A units and the remaining $126,000 was allocated to the son’s family trust on the Class C units.

The issues

The CRA reassessed to include 50% ($63,000) of the allocation to the son’s family trust in the taxpayer’s income in accordance with a specific provision in the Income Tax Act prohibiting the sharing of income in unreasonable proportions. The CRA’s view was that this treatment was appropriate because the taxpayer had invested 50% of the capital into the partnership and was responsible for 50% of the partnership’s conduct under the partnership agreement.

The taxpayer appealed to the TCC, arguing that, despite the nominal contributions of the holders of the Class C units, their income allocation was reasonable because it gave effect to the kind of corporate estate freeze that is generally considered acceptable income tax planning.

The Tax Court decision

The TCC Judge, Justice Cameron McArthur, stated that he began “from the premise that structured properly, a partnership can replace a typical estate freeze through a corporation.” However, he concluded that the terms of this partnership deviated substantially from a typical estate freeze, and therefore dismissed the appeal.

The main “deviation,” in the judge’s view, was that the value of the Class A units issued to the taxpayer was less than the value of the properties that had been transferred to the partnership in exchange for those units.

The judge considered the following main factors:

• The partnership agreement provided that all losses in respect of the properties were to be allocated to the Class A units held by the taxpayer.
• The Class A unitholders were required to fund cash requirements in relation to the ongoing operation of the properties.
• The taxpayer could not unilaterally have her Class A units redeemed.

The partnership agreement contained a price adjustment clause in respect of the redemption value of the Class A units issued for the properties in the event that the fair market value of the properties was redetermined by any tax authority. However, this did not assist the taxpayer, since it was not the value of the properties that was at issue, but the value of the units issued in exchange for the properties.

As a result, the TCC upheld the CRA’s reassessment, which included in the taxpayer’s income 50% of the 1994 partnership income that had been allocated to the family trust under the partnership agreement.

The Federal Court of Appeal decision

The taxpayer’s appeal to the FCA was dismissed on the basis that the TCC judge’s conclusion was reasonably open on the record before him. Unfortunately, the FCA did not express an opinion on the efficacy of partnership estate freezes:

“We note that Justice McArthur accepted the notion that it is possible to achieve an acceptable estate freeze through a partnership. We do not consider it necessary to express an opinion on that issue and we decline to do so.” (paragraph 7)

What the decision means

As a result of this decision, you should exercise caution before undertaking a partnership estate freeze. Be cognizant of a possible reallocation under the Income Tax Act’s unreasonable proportions provisions. And ensure that the relevant price-adjustment clause is drafted properly so it covers not only a redetermination of the value of the transferred properties, but also the value of the units issued in exchange for the properties.

When you can use a corporate freeze, it may be preferable to do so. Alternatively, if it is necessary to use a partnership freeze — for example, where the freeze property is land inventory or is otherwise not eligible for a corporate rollover — you should consider obtaining an advance ruling from the CRA.

Tax Alerts

 2011 Issue No. 4 - Finance fine-tunes GST/HST provisions for investment plans and pensions
On 28 January 2011, the Department of Finance announced proposals to modify its intricate scheme for levelling the GST/HST playing field for investment plans in response to concerns expressed by stakeholders. In this alert, we summarize the proposed changes to help you consider which are relevant to your circumstances. 

 2011 Issue Nos. 5, 6, 7, 8 - Provincial budget series
In February, four provincial and territorial budgets were presented – Yukon, Northwest Territories, British Columbia and Alberta.

For up-to-date information on the federal, provincial and territorial budgets, visit us at ey.com/ca/budget.

The CRA wants a piece of the $1.5-trillion transfer pricing pie: Canada among countries to see increased audit activity and penalties
Transfer pricing transactions between Canadian companies and their related parties outside Canada are valued at more than $1.5 trillion annually. With transfer pricing rules essentially dictating how much of a company’s profit will remain in each country, it’s no wonder the Canada Revenue Agency and other global tax authorities are focused on raising revenues through taxation. Read more.

Tax Policy & Controversy quarterly briefing
The February 2011 issue features articles on developments in China, Japan, Russia, the UK and the US, along with coverage of many themes and trends and an exclusive interview with Linda Lizotte-MacPherson, Commissioner and CEO of the Canada Revenue Agency. Read more.

Taxation administration without borders: a Canadian perspective
The world in which multinationals operate is changing dramatically. Adapting to these shifts requires global companies to think in new ways about their tax positions and overall approach to managing tax risk. They must engage with tax administrations and work in new ways to resolve disputes or avoid potential disputes before they occur.

In this report, a Canadian supplement to a global Ernst & Young report, we give you richer in-depth information on developments in Canada that can impact your business. Read more.

Ernst & Young’s Guide to Preparing 2010 Personal Tax Returns
Internet Edition or eBook
Editors: Gena Katz, Maureen De Lisser, Yves Plante, and Vivian Leung

Business immigration alerts and updates
For the latest information on Canadian and US business immigration issues from Egan LLP, a business immigration law firm allied with Ernst & Young LLP in Canada, visit eganllp.com.