TaxMatters@EY – December 2021

Alan Roth, Toronto

In last month’s edition of TaxMatters@EY, we included Part 1 of “Asking better year-end tax planning questions,” which looked at the questions, topics and tax planning techniques that may apply to you each year. In Part 2, we focus on the questions and topics that are specific to the 2021 taxation year and recent personal tax changes.

Specifically, in Part 2 we look at the personal tax implications of receiving COVID-19-related relief benefits, working from home, use of an employer-provided automobile, receiving stock options, purchasing a luxury boat or car, and receiving Old Age Security payments. Addressing these points can help you with the forward-looking planning process described in Part 1.

Did you receive COVID-19-related relief benefits from the government in 2021?

Various COVID-19-related relief benefits provided by the government — such as the Canada Recovery Benefit (CRB), Canada Recovery Sickness Benefit (CRSB), Canada Recovery Caregiving Benefit (CRCB) and the new Canada Worker Lockdown Benefit — are taxable.¹

Financial assistance payments received under a provincial or territorial COVID-19 relief program are also taxable. If you received benefits under any of these programs in 2021, you will be required to include the total amount in income on your 2021 income tax return.

If you operated an unincorporated business in 2021 and received any benefits under the Canada Emergency Wage Subsidy (CEWS), Canada Emergency Rent Subsidy (CERS) the Canada Recovery Hiring (CRHP), or the new Tourism and Hospitality Recovery or Hardest-Hit Business Recovery programs, the amounts received are deemed to be government assistance, and therefore taxable,² and will need to be reported on your 2021 income tax return as well.³

Because these benefits are all taxable, you will need to take them into account when estimating the amount of taxes you’ll owe for the 2021 taxation year.⁴

For details about the CRB, CRSB and CRCB programs, see EY Tax Alert Issue 2020 No. 45, Transition plan for the CERB announced, and TaxMatters@EY, November 2020, “Transition from the Canada Emergency Response Benefit. Bill C-4 receives Royal Assent.”

For further information about the CEWS program (since its July 2020 revision), see EY Tax Alert 2020 Issue No. 42, Redesign and extension of the Canada Emergency Wage Subsidy. See EY Tax Alert 2020 No. 52, Bill C-9 introduced to implement new rent subsidy and amend current wage subsidy, and EY Tax Alert 2020 No. 54, Federal government releases emergency support for commercial property renters and owners: an analysis of the Canada Emergency Rent Subsidy, for information on the CERS and updates to the CEWS program. For details about the CRHP as well as further updates to the CEWS and CERS, see EY Tax Alert 2021 No 19, Federal budget 2021–22: a recovery plan for jobs, growth and resilience.

For more information about the Tourism and Hospitality Recovery and Hardest-Hit Business Recovery programs, see EY Tax Alert 2021 No. 30, Finance announces targeted COVID-19 support measures.

Were you required to repay any COVID-19 related benefits?

If you received COVID-19-related benefits in 2020 or 2021, you are generally taxed on those benefits in the year of receipt. But if you are required to repay any benefits — for example, if it’s determined later that you were not eligible for them — you could previously claim a deduction only in the year of repayment. If the benefit was not repaid in the same year that it was received, the income inclusion and related tax liability would be in a different year than the deduction for repayment.

However, in accordance with recent legislative amendments, if you repay certain COVID-19- related benefits before 2023, you now have the option of claiming the deduction for the repayment amount in the year in which you received the benefit, rather than in the year you made the repayment. If you make the repayment after filing your tax return that reports the income inclusion, you can file an adjustment to that return. You can also split the deduction between the year you received the benefit and the year it was repaid, as long as the total deduction does not exceed the amount repaid. These amendments apply to repayments of the CRB, CRCB, CRSB (see above), the Canada Emergency Student Benefit (CESB), and the Canada Emergency Response Benefit (CERB). The CESB and CERB programs applied during the 2020 taxation year. Consider reviewing your 2020 and 2021 tax positions to determine when it would be optimal to claim the deduction for repayments of these benefits.

Have you been working from home as a result of the COVID-19 pandemic?

If you’ve continued or started to work from home in 2021 like many Canadians as a result of the COVID-19 pandemic, you may wonder to what extent you may deduct any related home office expenses. The Income Tax Act specifies the types of expenses incurred in a home office that employees or the self-employed may deduct and the conditions that must first be met to be able to deduct them.

For more information, see the following article by David Robertson and Laura Jochimski of EY Law: Could home office quarantine mean home office deductions?

The federal and provincial governments were, for much of 2020, relatively silent on their willingness to amend the rules for the deduction of home office expenses in any way or even to provide clarifications to the rules in light of the circumstances that have arisen in the face of the COVID-19 pandemic. However, the 2020 federal fall economic statement, delivered on November 30, 2020, noted that the Canada Revenue Agency (CRA) would permit employees who have been working from home in 2020 as a result of the pandemic to claim up to $400 in home office expenses. The claim would be based on the amount of time spent working from home, without the need to track detailed expenses. The CRA would generally not request that employees provide a signed form from their employers (e.g., a Form T2200) for these costs.⁵

The CRA provided further details on December 15, 2020, including new eligibility criteria,⁶ a new addition to the list of eligible expenses (internet access fees), a new streamlined process with simplified forms and a new temporary flat rate method to claim $2 per workday to a maximum of $400 for the year. Employees could choose either the temporary flat rate method or the detailed method. For more details, see EY Tax Alert 2020 No. 62, CRA issues guidance on employee home office expenses and Form T2200.⁷

For 2020, the CRA has also provided information on the taxation of certain benefits provided by employers to employees working from home as a result of the pandemic. The CRA has stated that the reimbursement of up to $500 for all or part of the cost of personal computer equipment to enable an employee to work remotely as a result of the pandemic is considered a tax-free benefit if the purchase is supported with receipts.

At the October 2020 Canadian Tax Foundation virtual conference CRA Roundtable, the CRA confirmed this position had been expanded to include home office furniture such as desks and chairs, provided they are needed for the employee to carry out their duties of employment from home. The CRA also clarified that the $500 limit applies per employee, and not for each purchase of equipment. As an example, the CRA noted that an employee who purchases both a work desk and a computer monitor may receive a reimbursement of up to $500 in respect of both purchases collectively without incurring a taxable benefit, provided the conditions of the administrative policy are otherwise met.⁸

The CRA also stated at another webinar in 2020 that if your regular place of employment is closed during the pandemic, the CRA does not consider employer-provided parking at that location to be a taxable benefit to you. If you are still going to your employer’s place of business to work, the CRA noted that it does not consider a reimbursement or reasonable allowance for travel expenses related to commuting in a motor vehicle from an employee’s home to a regular place of employment to be a taxable benefit if your presence at the office is required and the office is closed.

If the office is open, “additional travel costs” to pick up home office equipment, for example, are not taxable benefits. For example, if you normally commute via public transit, the extra cost incurred to use your car for safety reasons is considered an additional travel cost in this context.

In addition, travel expenses incurred from the employee’s home to their place of work using a motor vehicle provided by the employer under similar circumstances to those outlined above is considered to be business mileage and, therefore, not included as a taxable benefit.

For further information, see EY Tax Alert 2020, Issue No. 50, CRA update on CEWS and employee benefits.

If your employer reimbursed you for computer equipment or furniture to enable you to work from home during the pandemic, ensure you keep your receipts from your purchases. If you have been going to work at your employer’s place of employment, ensure you also retain a log of kilometres driven that were related to your travel from home to work.

Does your employer provide you with the use of an automobile for personal purposes?

If your employer provides you with access to an automobile for personal use, you are required to pay tax on this benefit. This is referred to as a standby charge and is generally equal to 2% of the original cost of the automobile per month or, in the case of a leased vehicle, two-thirds of the lease cost, excluding insurance. You may be able to reduce this standby charge if you use the automobile primarily (i.e., more than 50%) for business and if your annual personal driving does not exceed 20,004 km. Recent legislative amendments allow employees to use their 2019 automobile usage to determine whether an employer-provided automobile is used primarily for business purposes to access the reduced standby charge for the 2020 and 2021 taxation years. But you must be working for the same employer as in 2019 to qualify.

If your employer pays any operating costs related to your personal use of the employer’s automobile, a taxable benefit also results. However, if you use the automobile at least 50% of the time for business purposes, you may have the operating benefit calculated as one-half of the standby charge less any personal operating costs repaid to your employer within 45 days after the year end. For this option, you must notify your employer in writing.

Recent legislative amendments allow employees to use their 2019 automobile usage to determine the availability of the optional method for calculating the operating benefit as 50% of the standby charge for the 2020 and 2021 taxation years. But you must be working for the same employer as in 2019 to qualify and, if you do, you may be entitled to this treatment without having to notify your employer.

These legislative amendments are intended to address the impact of COVID-19 lockdowns and public health measures on an employee's business or personal mileage as compared with a normal year.

Does your employer grant stock options to any of its employees?

Recent amendments limit the availability of the 50% employee stock option deduction⁹ to an annual maximum of $200,000 of stock options that vest (become exercisable) in a calendar year, based on the fair market value of the underlying shares on the date of grant. These amendments are intended to restrict the preferential treatment of stock options for employees of large, long-established, mature companies while continuing to provide full tax benefits for persons employed by Canadian-controlled private corporations (CCPCs) and startup, scale-up or emerging Canadian businesses (these terms were not defined in the original proposals that were introduced in 2019).

The government opted for a revenue test as a proxy for “startup and scale-up” companies. As a result, the $200,000 annual limit does not apply to stock options granted to employees by CCPCs or non-CCPCs with annual gross revenue of $500 million or less.¹⁰

The amendments are effective for stock options granted on or after July 1, 2021 (other than qualifying options granted after June 2021 that replace options granted before July 2021).

The following example illustrates the impact of these amendments:

Your employer, a corporation whose shares are publicly traded, grants you 10,000 options to purchase shares of the company for $100 per share in August 2021, when the fair market value of the shares is also $100 per share. Therefore, the value of the shares represented by the options at the time of grant is $1,000,000. Half of the options granted will vest in 2022 and the remainder will vest in 2023. In its financial statements, the company reported gross revenues exceeding $500 million for the fiscal year that ended immediately prior to the issue of the options.

If you exercise 5,000 options in July 2022 and the fair market value of the shares at that time is $120 per share, you will recognize a stock option benefit of $100,000 (5,000 x ($120 - $100)). The proportion of the options exercised in 2022 that will not qualify for the stock option deduction under these amended rules is calculated as the fair market value of the underlying shares on the option grant date of $500,000 (5,000 x $100) minus the $200,000 limit = $300,000. Therefore, 3,000 (i.e., 5,000 x ($300,000/$500,000)) of the 5,000 options vesting in 2022 will not qualify for the deduction. The fair market value of the shares on the grant date that are represented by the 2,000 options that qualify for the deduction equals the $200,000 annual limit (2,000 x $100 per share)). You will be able to claim a stock option deduction of $20,000 (i.e., 50% x 2,000 x ($120 - $100)) for the 2022 taxation year.

For further information on these amended rules, see EY Tax Alert 2020 No. 57, Income tax measures from the 2020 federal Fall Economic Statement, EY Tax Alert 2020 No. 59, Stock option proposals reintroduced, EY Tax Alert 2021 No. 26, Proposed changes to taxation of employee stock options now law, and TaxMatters@EY, May 2021, “Proposed limitations to the security option deduction.”

Are you planning a luxury vehicle or boat purchase?

The 2021 federal budget proposed to introduce a tax on the retail sale of new luxury cars and personal aircraft priced over $100,000 and boats priced over $250,000, effective January 1, 2022. These thresholds do not include applicable sales taxes. For vehicles and aircraft priced over $100,000, the amount of the tax would be the lesser of 10% of the full value of the vehicle or the aircraft, or 20% of the value above $100,000. For boats priced over $250,000, the amount of the tax would be the lesser of 10% of the full value of the boat or 20% of the value above $250,000.

These proposals were subject to a consultation that ended on September 30, 2021. At the time of writing, draft legislative amendments had not yet been introduced. Consult your EY Tax advisor for the latest information in respect of these proposals.

Are you eligible for OAS, and will you be 75 or older by June 30, 2022?

If you were eligible for the Old Age Security (OAS) government pension as of June 2021, have been approved for it and will be 75 or older as of June 30, 2022, you should have received a one-time grant payment of $500 in August 2021. This payment is taxable and will need to be included in income on your 2021 income tax return. You will receive a tax slip early in 2022 that reports this amount.

If you have applied for the OAS pension but have not been approved, if you haven’t yet applied, if you were born on or before June 30, 1947, if you are eligible for the OAS and apply before May 31, 2022, you may be eligible for a retroactive payment of the one-time benefit. Note also that maximum benefits payable to OAS recipients age 75 and older will be automatically increased by 10% effective July 1, 2022.

Conclusion

There are two benefits to doing year-end tax planning while there is enough time left in the year to do it well. First, you’re more likely to avoid surprises next April that can be both financially and emotionally stressful. Second, if done from the wide-angle perspective of comprehensive financial and estate planning (as discussed in Part 1 of “Asking better year-end tax planning questions”), year-end tax planning can help you understand whether you’re doing the right things in the right way, not just to minimize income taxes, but also to make it that much easier to achieve your longer-term financial goals.

The suggestions made in both Part 1 and Part 2 of “Asking better year-end tax planning questions” should help you set the agenda for a comprehensive discussion with your tax advisor this year and in years to come.

Wes Unger, Saskatoon

Corporate business owners have great flexibility in making decisions about their remuneration from a private company. This flexibility is available to all types of businesses, including incorporated professionals and business consultants. However, the planning process is not a simple one, as there are many tax issues that must be addressed. It’s important that decisions about remuneration be considered before year end, as well as during the business’s financial statement and tax return finalization processes.

The federal government’s proposals on income sprinkling were enacted in 2018 and are applicable to 2018 and later years (See Rules limit income splitting after 2017 below). These rules have impacted some of the traditional planning that was previously available to corporate business owners.

In addition, the 2018 budget introduced legislation impacting the taxation of private corporations in 2019 and later years. Further discussion of these rules continues below.

Rules limiting income splitting after 2017

The tax on split income (TOSI) rules introduced in 2017 broadened the base of individuals affected and increased the types of income subject to the existing rules, (formerly known as “the kiddie tax”) aimed at preventing income splitting. In essence, the TOSI rules limit income splitting opportunities with most adult family members through the use of private corporations after 2017.

Beginning in 2018, any income received by an individual that is derived directly or indirectly from a related private company (with the exception of salary) could be subject to the TOSI legislation. Any income subject to TOSI will be taxed at the highest marginal tax rate, which eliminates any tax advantage. To avoid application of the TOSI, the type of income needs to meet one of the exceptions or the individual receiving the income must fall into one of the exclusions. The application of the rules will also depend on the age of the individual receiving the income.

Exclusions are provided to recipients who are actively engaged in the business, as well as to payments that represent a reasonable return (based on a number of factors) and payments received by certain shareholders. Certain other exclusions are also provided. For more information, refer to EY Tax Alert 2017 No.52, Finance releases revised income splitting measures, and the February and May 2018 issues and February and November 2020 issues of TaxMatters@EY.

Basic considerations

In general, if a corporate owner-manager does not need personal funds for spending, earnings should be left in the corporation to generate additional income and defer personal tax until a later date when personal funds are needed. For 2021, this tax deferral benefit resulting from the difference between corporate tax rates and personal tax rates can range, for individuals taxed at the highest marginal tax rate, from as little as 20.4% in Prince Edward Island when applying the general corporate tax rate, to as high as 42.5% when applying the small business corporate tax rate in Nova Scotia and British Columbia.

Deferring personal tax allows you to reinvest the corporate earnings and earn a rate of return on the personal tax you would have otherwise paid if you had extracted the funds from the business.

For fiscal years starting in 2019, the amount of income eligible for the federal small business deduction is generally reduced if the corporation (together with all associated corporations) has passive investment income greater than $50,000 in the previous year and is eliminated entirely if the amount of passive investment income exceeds $150,000, similar to the reduction that is applied to a corporation whose taxable capital exceeds $10m in the prior year. See the May 2018 issue of TaxMatters@EY.

A corporation with too much passive investment income in the prior year will be taxable on its active business income at the general corporate rate.¹ Paying tax at the higher general corporate tax rate will decrease the amount of the tax deferral benefit but will allow the corporation to pay out eligible dividends in the future. Not all provinces have decided to follow this federal provision.²

Even if funds are not required for personal consumption, business owners may want enough salary to create sufficient earned income to maximize their RRSP contribution and use tax savings associated with graduated income tax rates. Whether or not this is an appropriate strategy depends on an overall review of the owner-manager’s financial plan for the near future and the long term.

To contribute the maximum RRSP amount of $29,210 for 2022, business owners will need 2021 earned income of at least $162,278. One method to generate earned income is to receive a salary in the year. Note that salary must be earned and received in the calendar year. Receipt of a salary would also allow the business owner to maximize CPP pensionable earnings for the year (based on maximum pensionable earnings of $61,600 for 2021).

If funds are needed for personal consumption, the CRA has a longstanding policy of not challenging the reasonableness of remuneration where the recipient is active in the business and is a direct or indirect shareholder. This criterion of reasonableness is relevant when considering if the remuneration is deductible to the paying corporation.

It’s generally more advantageous to distribute corporate profits as a salary or bonus to an active owner-manager based on current provincial corporate and personal tax rates. However, this may not be applicable for all provinces, and certain provinces levy additional payroll taxes, such as Ontario’s employer health tax, which may impact an analysis of the optimal compensation strategy.

In almost all provinces there is an overall “tax cost” to distributing business profits in the form of a dividend, meaning the total corporate and personal tax paid on fully distributed business earnings exceeds the amount of personal tax that would be paid in that province if the individual earned the same amount of income directly. However, business owners may still wish to earn money through a corporation and defer the tax if future cash needs can be satisfied by salaries or bonuses from future profits.

Earnings subject to a large deferral of tax can remain reinvested in the business or corporate environment for many years, sometimes indefinitely. However, this strategy has to be used carefully, because accumulating excessive business earnings could impact the corporation’s ability to claim the small business deduction on its active business income in the future. See the previous discussion on passive investment income changes. It could also affect a shareholder’s ability to claim the lifetime capital gains exemption (see comments on QSBC shares below).

Advanced considerations

Shareholder loans made to the corporation can be repaid tax free and represent an important component of remuneration planning. Advance tax planning may permit the creation of tax-free shareholder loans.

Complex tax rules associated with otherwise tax-free intercorporate dividends could result in the dividends being recharacterized as capital gains. However, advance tax planning may be available to mitigate this issue, and it also may be possible to benefit from corporate distributions taxed at reduced tax rates associated with capital gains.

A business owner who holds personal investments such as marketable securities can sell them to a private corporation in exchange for a tax-paid note or shareholder loan. While capital gains may arise on the transfer, the personal tax rate on capital gains is generally lower than the personal tax rate on eligible or non-eligible dividends. Advance tax planning may also allow recognition of the capital gain to be deferred, but tax losses may not be realized on a transfer to an affiliated corporation.

Corporate-level merger and acquisition transactions, such as the divestiture of a business or real estate, may also generate favourable tax attributes such as tax-free capital dividend account (CDA) balances or refundable taxes. These attributes form an important component of remuneration planning.

A business can claim a capital cost allowance (CCA) deduction for the purchase of depreciable assets that are available for business use on or before the business’s fiscal year end. A business that is contemplating a future asset purchase and has discretion in the timing of acquisition may choose to make the purchase sooner rather than later and then bring the asset into use to allow a CCA to be claimed. This strategy should be carefully considered in light of the opportunities for an enhanced CCA deduction currently available. Refer to EY Tax Alerts 2019 Issue No. 15 and 2018 Issue No. 40.

The 2021 federal budget proposed to enhance the CCA deduction for certain assets acquired by a CCPC after April 18, 2021. This proposal will allow a CCPC to deduct the full cost of certain assets purchased up to a maximum of $1.5 million per year (to be shared with other members of an associated group of CCPCs) provided the asset is available for use prior to January 1, 2024. Refer to EY Tax Alert 2021 Issue No. 19.³

Retaining earnings in a corporation may affect a CCPC’s entitlement to refundable scientific research and experimental development (SR&ED) investment tax credits. A business should compare the investment return from deferring tax on corporate earnings against the forgone benefit of high-rate refundable SR&ED investment tax credits.

Leaving earnings in the corporation may also impact the status of the corporation’s shares as qualified small business corporation (QSBC) shares for the purpose of the shareholder’s lifetime capital gains exemption (currently $892,218). Advance tax planning may be available to mitigate this issue and permit continued accumulation of corporate profits at low rates without impacting the QSBC status of the shares.

A private member’s bill received Royal Assent on June 29, 2021 (Bill C-208). This new legislation was introduced to facilitate intergenerational transfers of family businesses. The Department of Finance has indicated that amendments to this legislation will be introduced in the future to address unintended tax avoidance loopholes. Refer to EY Tax Alert 2021 Issue No. 25.⁴

Paying dividends may occasionally be a tax-efficient way of getting funds out of a company. Capital dividends are completely tax free, and eligible dividends are subject to a preferential tax rate. For fiscal years that begin after 2018, eligible dividends are only eligible to generate a dividend refund out of the eligible refundable dividend tax on hand (ERDTOH) account.

Non-eligible dividends can generate a dividend refund out of the ERDTOH and the non-eligible refundable dividend tax on hand (NERDTOH) account. A review of the company’s tax attributes will identify whether these advantageous dividends can be paid.⁵

Dividends and other forms of investment income from private corporations do not represent earned income and so do not create RRSP contribution room for the recipient. An individual also requires earned income to be able to claim other personal tax deductions, such as child care and moving expenses. Business owners should consider how much earned income they need in light of the RRSP contributions they wish to make or personal tax deductions they wish to claim.

Income splitting considerations (subject to TOSI)

Consider paying a reasonable salary to a spouse or adult child who provides services (e.g., bookkeeping, administrative, marketing) to the business in order to split income.

If a spouse or adult child (older than 24 years of age) is not active in the business and has no other sources of income, consider an income-splitting corporate reorganization whereby the family members become direct shareholders in the business, owning 10% or more of the votes and value of the corporation. This planning is still available even with the TOSI rules in effect, as long as the corporation is not a professional corporation and has less than 90% of its gross business income from the provision of services and at least 90% of the company’s income is not derived directly or indirectly from one or more related businesses.

For non-active family members, there generally must be a direct shareholding as described above.⁶ Non-active family members are no longer able to be indirect shareholders and avoid the TOSI legislation. Active family members can be indirect shareholders and avoid the TOSI legislation, as long as they fit into one of the exclusions under the TOSI rules.

Depending on the province of residence, an individual who has no other source of income can receive a certain amount of dividends tax free. For eligible dividends, the range would be $18,740 to $53,810, and for non-eligible dividends the range would be $10, 255 to $30,170. These amounts increase where the recipient has access to tax credits such as the tuition tax credit in the case of adult-children students.

Commercial and family law considerations, in conjunction with the tax benefits, will determine whether it’s worthwhile pursuing such a strategy. In select cases, a low-interest family loan can be advantageous for permissible income splitting. Given the low 1% “prescribed rate,” it may be worthwhile exploring this planning option, especially if the return on investment exceeds the prescribed rate.

Managing tax cash flow⁷

If there’s a plan to pay a salary, remember that bonuses can be accrued and deducted by the business in 2021, but not included in the business owner’s personal income until paid in 2022. To be deductible to a corporation, the accrued bonus must be paid within 180 days after the company’s year end, permitting a deferral of tax on salaries of up to six months.⁸

If earnings left in the corporation exceeded the available small business deduction limit for the preceding tax year, corporate taxes for the current year will be due two months, rather than three months, after the year end. The current rate for late payment arrears interest is 5% and is not deductible for income tax purposes.

Monthly and quarterly tax instalments (for corporate and personal income, respectively) must be managed to avoid arrears interest and penalty interest. A single midyear payment strategy can be used to simplify the obligation of making recurring payments, and generally reduce or eliminate interest and penalties.

Use of a shareholder “debit” loan account (where the corporation has a receivable from the individual shareholder) may simplify the need to project exact owner-manager remuneration requirements. Shareholder debit loans must be repaid within one year after the end of the year in which the loan was made, or else the loan will be included in the business owner’s income in the year funds were withdrawn. The repayment of a shareholder loan cannot constitute a series of loans or other transactions and repayments if the one-year repayment is to be considered valid.⁹

Borrowing from the company within the permissible time limits will cause a nominal income inclusion at the prescribed rate, which is currently only 1%. The cost of financing from the corporation using shareholder loans can therefore currently be achieved at tax-effected rates of 0.475% to 0.54% at the highest marginal tax rates, depending on your province of residence.

For more information on remuneration planning and other tax-planning and tax-saving ideas, contact your EY advisor.

Winnie Szeto, Toronto, and Gael Melville, Vancouver

In this recent case, the Tax Court of Canada ruled that, under paragraph 161(7)(b) of the Income Tax Act (the Act), when a taxpayer makes a written request to carry back non-capital losses to offset tax payable that arose in a previous taxation year as result of a reassessment, arrears interest accrues from the balance due date of the taxation year the loss was to be applied until the date of the carryback request. This result was a significant loss for the taxpayer as it meant that it was liable for almost six more years of arrears interest.

Facts

The taxpayer was a Canadian bank with a taxation year end of October 31. On April 28, 2009, the taxpayer filed its 2008 income tax return and reported a non-capital loss of approximately $4 billion, which was later reduced to approximately $3.3 billion due to subsequent adjustments the Canada Revenue Agency (CRA) made.

During 2013 and 2014, the CRA performed a transfer pricing audit of one of the taxpayer’s foreign subsidiaries’ 2006 to 2010 taxation years. In February 2015, the CRA issued a proposal letter to the taxpayer in respect of the audit of the 2006 taxation year. On March 13, 2015, the taxpayer and the CRA agreed to enter into a settlement agreement in respect of the transfer pricing audit. The agreement provided that the CRA would reassess the taxpayer to include certain transfer pricing adjustments in the taxpayer’s 2006 to 2014 taxation years. These adjustments resulted in an increase to the taxpayer’s 2006 taxable income of approximately $54.9 million.

On March 12, 2015, the taxpayer wrote to the CRA to request that $54 million of non-capital losses that arose in the taxpayer’s 2008 taxation year be carried back to offset the $54.9 million of income that arose in the 2006 taxation year due to the transfer pricing adjustments.

On March 20, 2015, the CRA issued a notice of reassessment for the taxpayer’s 2006 taxation year, whereby the taxpayer’s taxable income was increased by the transfer pricing adjustment of $54.9 million, in accordance with the settlement agreement, and the 2008 non-capital loss of $54 million was carried back and applied to offset the increased income. In addition, the CRA assessed arrears interest of approximately $7.9 million, which represented interest that accumulated between 2006 and the deemed payment date of March 12, 2015, the date the taxpayer requested the loss carryback.

The taxpayer disagreed with the CRA’s calculation of arrears interest based on a deemed payment date of March 12, 2015 and, as a result, appealed to the Tax Court.

Tax Court decision

At trial, the judge had to decide which date constituted the deemed payment date for calculating arrears interest.

The relevant tax law provides that if an amount of tax payable for a taxation year (i.e., the 2006 taxation year) is reduced because of the carryback of losses from a subsequent year (i.e., from the 2008 taxation year), interest on any unpaid tax for the 2006 taxation year is to be calculated as if no reduction occurred until 30 days¹ after the latest of the following dates:

• The first day immediately following the loss year, November 1, 2008
• The day the taxpayer’s income tax return for the loss year was filed, April 28, 2009
• If the CRA reassessed the taxpayer’s tax for the year to take into account the loss deduction as a consequence of a written request, the day on which the request was made, March 12, 2015²

Taxpayer’s arguments

The taxpayer argued that the interest should be calculated based on the filing date of the loss year return — April 28, 2009. It believed Parliament did not intend for taxpayers to be charged interest during periods when a loss was available to be carried back but the taxpayer didn’t know it had to do so until the CRA had completed its audit. The taxpayer noted that other discretionary deductions were not subject to such interest calculation when they were applied to offset an audit adjustment.

Furthermore, the taxpayer argued that the CRA reassessed it for making the transfer pricing adjustments and not for effecting the loss carryback request. As a result, it argued, interest should be calculated based on the filing date of the loss year return — April 28, 2009 — and not the date on which the loss carryback request was made — March 12, 2015.

Finally, the taxpayer relied on the Methanex³ case in support of its position that interest should be calculated based on the filing date of the loss year return.

CRA’s arguments

The CRA argued that the interest should be calculated based on the date of the taxpayer’s written request to carry back the loss — March 12, 2015 — because the words of the tax provision are clear, so the Tax Court should respect their ordinary meaning. The CRA argued that the existence of a loss carryback from a subsequent year did not mean that a tax debt from an earlier year was never owed. Instead, the tax debt of an earlier year is owed until a loss carryback is requested, which in this case was March 12, 2015.

The CRA also rebutted the taxpayer’s argument that the CRA reassessed the taxpayer for making the transfer pricing adjustments, and not for effecting the loss carryback request. It noted that the CRA could have issued two separate notices of reassessment, one for the transfer pricing adjustments and another for the loss carryback, so the deemed payment date would have been the day on which the loss carryback request was made, March 12, 2015.

Finally, the CRA relied on the Connaught⁴ case in which the Federal Court ruled that where losses were carried back and resulted in no tax payable, arrears interest was still payable on the tax that would have been payable but for the loss carryback. The Federal Court in that case also found that the wording of the relevant provision was unambiguous and that the CRA’s interpretation of it did not contravene the purpose or objects of the Act.

Tax Court’s analysis

After an analysis of modern statutory interpretation, Parliament’s intention as detailed in technical notes⁵ relating to the relevant provision and case law⁶, the trial judge disagreed with the taxpayer’s arguments. She found that in a self-assessing system, the onus was on the taxpayer — that is, the taxpayer was liable for tax owing regardless of where in the assessment process the taxpayer was. She found that the wording of the provision was unambiguous, and that Parliament intended for it to operate in accordance with the CRA’s position.

Finally, the judge agreed with the CRA that the current situation was more like the Connaught case than the Methanex case, and that “Methanex [was] either wrongly decided or its reasoning [could not] be applied to an appeal under the federal Income Tax Act.”

Based on the above reasons, the appeal was dismissed.

Lessons learned

The results of this case are particularly severe for the taxpayer. One can argue that this interpretation of the provision is essentially assessing interest during a period when no tax is actually due. However, the Tax Court noted that the Act contemplates retroactive or retrospective liability following reassessment in a self-assessing system. That said, if a taxpayer does not know about a tax liability until many years later after an audit, it seems wrong that they have to pay interest for the intervening years. It’s hard to see how this can be considered fair.

It’s interesting to note that in the past, the CRA has acknowledged that the purpose of paragraph 161(7)(b) was to prevent situations where a taxpayer deliberately refused to pay taxes in a year, in anticipation of incurring losses in a subsequent year that could be carried back to eliminate the previous year’s tax liability. Where there were no indications of such tax avoidance, the CRA was willing to accept that arrears interest should accrue only until the filing date of the taxpayer’s loss year tax return, and not until the day of the request for loss carryback.⁷ It appears the CRA has not been totally consistent over the years in its approach to such matters.⁸

Taxpayers seeking to carry back losses to offset increases in income due to audit adjustments would be well advised to seek the assistance of professional tax advisors. As of writing, it remains to be seen if the taxpayer will appeal the decision to the Federal Court of Appeal.

Tax Alerts – Canada

Tax Alert 2021 No. 30 – Finance announces targeted COVID‑19 support measures
The Canada Emergency Wage Subsidy and the Canada Emergency Rent Subsidy (including the lockdown support) expired on 23 October 2021 (end of period 21). In their place, the government announced new targeted COVID-19 support measures in addition to an extension of the Canada Recovery Hiring Program.

Tax Alert 2021 No. 31 – Deadline to convert Health and Welfare Trusts to Employee Life and Health Trusts 
is imminent
The CRA’s existing administrative rules with respect to Health and Welfare Trusts (HWTs) are only effective until 31 December 2021.

Tax Alert 2021 No. 32 – New Manitoba PST registration requirements for nonresidents in the digital economy
On 14 October 2021, Manitoba amended The Retail Sales Tax Act requiring “online accommodation platforms”, “online sales platforms” and other digital service providers to be registered for and collect provincial sales tax (PST) at 7% from customers located in Manitoba.