Insurers are required to collect tax on insurance premiums, and remit it to the provincial government, within a certain allotted time.
When clients sent a cheque or made an electronic payment to pay their premiums before it was due on the effective date of the policy, one insurer accepted the sums as soon they were received but did not yet remit to the tax authorities because the policy was not yet in force.
The Quebec Court of Appeal nixed that practice.
The insurer, as per s. 527 of the Act respecting the Québec sales tax (Act), must in its capacity as agent account for the tax collected in the preceding calendar month at the end of the month, held the Appeal Court in Agence du revenu du Québec c. Assurances générales Desjardins inc., 2022 QCCA 57. Whether or not the premium is due does not change the fact that the insurer has collected the amount of tax on insurance premium paid by the insured and must therefore remit it to the Minister, added the Appeal Court.
“There is no doubt that, where the premium is paid on the day the contract comes into force, the tax on insurance premiums collected must be remitted to the Minister in accordance with the terms of section 527 of the Act.
“The issue at stake here is that the customer voluntarily fulfills his obligation, the payment of the amount corresponding to the premium, which includes the tax on insurance premiums, before the arrival of the suspensive term agreed between the parties and that the (insurer) collect this amount although they are technically not yet entitled to it.”
On top of that, under article 2398 Civil Code, this contract is formed as soon as the application is accepted by the insurer, even if it takes effect at a later date, added the Appeal Court. The enforceability of the reciprocal obligations of the parties is then simply suspended until the date fixed, concluded the Appeal Court.
Taxpayers are entitled to use the mark-to-market method to compute income for federal tax purposes if it provides a more accurate picture of a taxpayer’s income, ruled the Federal Court of Appeal.
The federal appeal court decision bolsters the possibility for taxpayers to use methods to compute income that are not forbidden by the Income Tax Act (Act), affirms Canada Revenue Agency’s administrative position that allows regulated financial institutions to tax derivatives on a mark-to-market basis, and may open the door to allow financial accounting to become more influential in determining what constitutes an acceptable method of computing income from business, according to tax experts.
“The case confirms that taxpayers are to determine profit for tax purposes on the basis that reflects an accurate picture of the taxpayer’s income,” said James Morand, a Toronto tax lawyer with Cassels Brock & Blackwell LLP. “If mark-to-market presents a truer picture of a taxpayer’s income than realization or some other method of computation, it is preferable.”
Kruger Inc., a Montreal newsprint and paper products manufacturing company that generated approximately 80 per cent of its sales in the U.S., started a business during the 1980s that purchased and sold foreign currency option contracts in order to reduce its exposure to foreign currencies. That line of business became so successful that it eventually became an industry leader in the Quebec options market, ranking among the top three or four non-banking enterprises in Quebec, behind the Caisse de dépôt et placement du Québec and Hydro-Québec. Beginning in 1997, Kruger began to account for its foreign exchange operations using mark-to-market accounting for financial reporting purposes. In 1998, Kruger’s foreign exchange operations claimed a loss of approximately $91 million, which the CRA denied.
Former Chief Justice of the Tax Court of Canada Gerald Rip denied the mark-to-market losses on option contracts written by Kruger. Although he found that the mark-to-market method was consistent with well-accepted business principles and generally accepted accounting principles (GAAP), former Justice Rip held that “a general principle of taxation is that neither profits nor losses are recognized under the Act until realized except if the Act provides an exception to the realization principle.”
Mark-to-market accounting is an accrual method of accounting where the option is valued at market value as at the balance sheet date, and any change in the market value from the beginning to the end of the period is recognized as a gain or loss in the income statement for the period. In contrast, under the realization method of accounting, a transaction is recognized as complete when an entity has a claim to be paid in cash or an obligation to pay cash. The realized value is certain, and not subject to any estimate of value.
But the federal appeal court, in overturning the lower court decision, rejected the notion that the realization principle is an “overarching” principle that applies in the absence of a provision authorizing or requiring the application of a different method. Such an approach flies in the face of established case law and runs counter to decisions by the Supreme Court of Canada, said Chief Justice Marc Nöel in a unanimous 34-page ruling in Kruger Incorporated v. Canada, 2016 FCA 186.
The SCC held, in Canderel Ltd. v. Canada,  1 S.C.R. 147 and in Ikea Ltd. v. Canada,  1 S.C.R. 196, that the realization principle can give way to other methods of computing income (pursuant to section 9 of the Act) “where these can be shown to provide a more accurate picture” of the taxpayer’s income for the year. In another decision issued some fifty years ago, the SCC held in Canadian General Electric Co. v. M.N.R.,  S.C.R. 3 that gains and losses on income account resulting from foreign currency fluctuation may be recorded on an accrual basis for tax purposes.
“The decision reinforces the possibility for a taxpayer to use any method that is not forbidden by the Act or rules of law,” noted Louis Tassé, a tax lawyer with EY Law LLP, who successfully plead the case. “Our position from the beginning was that Kruger was allowed to use mark-to-market as it gave a clearer picture of its income and was not otherwise forbidden by the Act or by case law. The decision is a simple application of the principles outlined by SCC in Canderel. It might serve as a healthy reminder of such principles.”
The appeal court also noted that there is “broad recognition” of mark-to-market accounting for the purpose of computing income from dealing in foreign exchange options. Uncontested evidence revealed that banks, financial institutions and mutual funds that deal with foreign exchange options have been given the green light by CRA to report their income using the mark-to-market method, pointed out the appeal court. It is also a method that is “consistent” with well-accepted business principles, GAAP and international accounting, added the appeal court.
“This is an important case because it significantly extends the SCC decision in the Canadian General Electric case,” said Neal Armstrong, a Toronto tax lawyer with Davies Ward Phillips & Vineberg LLP. “Until the Kruger case people thought that Canadian General Electric was restricted to the foreign exchange situation. Kruger extends mark-to-market accounting to a broader range of matters where the instruments are held in income account.”
In fact the appeal court decision seems to suggest that a taxpayer which has derivatives, other property or obligations acquired or incurred on income has the option to report its gains or losses on those holdings on a mark-to-market rather realization basis for tax purposes if, under GAAP, the taxpayer prepares financial statements on a mark-to-market basis, added Armstrong.
But taxpayers cannot switch between mark-to-market and realization tax accounting methods depending on whether they have accrued losses, said Paul Ryan, a Montreal tax lawyer with Ravinsky Ryan Lemoine LLP. The courts and CRA require that taxpayers use a consistent method of computation from year to year, added Ryan. “There has to be consistency as the federal appeal court decision points out,” said Ryan. “A taxpayer cannot choose one method when he has suffered losses, and another method when he’s making gains. That is very important.”
Some have suggested that the appeal court decision may have wider implications. In a bulletin PwC said that it is possible that the Kruger decision “will start a trend” in which financial accounting becomes more influential in determining what constitutes an acceptable method of computing income from a business.
Tassé says only time will tell. Morand believes the courts will continue to rely on the guidance set out by the SCC in Canderel and Ikea – that is, determining profit for tax purposes on a basis which reflects the most accurate picture. “This may be consistent with financial accounting but the fact that it is will not be determinative of whether it should be used for tax profit computation,” said Morand. In a similar vein, Armstrong said that while accounting principles do have some relevance, they are certainly not binding. “And the Kruger case hasn’t changed that,” added Armstrong.
Nearly six months after 20 Revenue Quebec officials raided the Montreal offices of Uber Canada Inc. as part of a tax investigation, the popular ride-sharing service won a legal battle against the provincial taxman after the Quebec Court of Appeal overturned a lower court ruling and held that the seized evidence must be sealed.
The succinct 12-page ruling will likely pave the way for more applications for impoundment as the courts and tax authorities grapple with the challenges posed by e-commerce, disruptive business models, and technology, according to tax lawyers.
“The ruling demonstrates that the courts and tax authorities have no choice but to adapt to today’s technology,” noted Alexandre Dufresne, managing partner of Spiegel Sohmer in Montreal. With laptops, smartphones, tablets likely to contain business — and personal — information, “the courts are coming to grips over how to deal with the issue of search warrants and privacy, which is a constitutionally protected right.”
The San Francisco-based firm first launched in Montreal in 2013 as a mobile application that allowed users to hail a cab using their smartphones. In late 2014 the firm drew the ire of tax drivers – and the attention of authorities — after it introduced its UberX service, which allows people to use their own cars in order to offer lifts to customers for money. Montreal taxi drivers, like elsewhere around the world, have argued that Uber enjoys an unfair advantage, compromises their ability to make a living, and is illegal. Montreal’s taxi bureau has ramped up its efforts to crack down on UberX drivers and seized more than 400 vehicles last year.
In May 2015, six months after the launch of UberX, Uber faced more legal headaches. Revenue Quebec obtained two search warrants under the Tax Administration Act to seize computers, cellphones, tablets and documents from Uber’s Montreal offices, based on a sworn statement that alleged that information contained in the high tech devices would prove that it breached tax laws. Following the execution of the warrants, Uber brought a certiorari application before Superior Court seeking to quash the warrants, based on provisions of the Code of Penal Procedure, the Quebec Code of Civil Procedure as well as the Canadian and Quebec charters. While awaiting the outcome of the certiorari application, Uber also applied for a safeguard order, requesting that the seized be impounded based on articles 8 and 24 (1) of the Canadian Charter.
The trial judge, heeding guidance from an Quebec appeal court decision in Constructions Louisbourg Ltée c. Agence du revenu du Québec 2011 QCCA 1636, refused to grant the application for impoundment. The judge held that allowing Revenue Quebec to examine the seized material would not cause Uber irreparable harm, that Uber’s expectation of privacy with respect to regulated activities was low, and that the balance of convenience weighed in favour of the taxpayers’ right to have tax laws respected and investigations seen through to the end.
The Quebec Court of Appeal overturned the ruling. In a unanimous decision in Uber Canada Inc. c. Agence du revenu du Québec 2016 QCCA 1, the three-judge panel held that the lower court judge “erred in his assessment” of the harm Uber would suffer if the impoundment was denied. The appeal court noted that the seized documents in the Louisbourg case were “exclusively” commercial, and were seized by Revenue Quebec from Revenue Canada offices, under no objection from Louisbourg.
That was not the case in the Uber case, pointed out the appeal court. The property seized at Uber’s Montreal offices contained information that was not “strictly commercial.” Rather, there is a “significant risk” that the information found on the laptops and smartphones belonging to Uber employees was private in nature, and beyond the scope of the search warrants. In a catchy phrase that will likely be repeatedly cited, the appeal court noted that “information cannot be unlearned and documents cannot be unread.” The scope of the seizure, the premises where the searches were performed, and “the allegations by Revenue Quebec read in conjunction with the minutes of the seizure sufficiently demonstrate” the existence of irreparable harm, held the appeal court.
“Following the Louisbourg decision, there were doubts within the legal community whether applications for impoundment had a chance of succeeding,” said Montreal tax lawyer Paul Ryan. “The appeal court reiterates in the Uber case that the expectation of privacy is relatively low when it comes to commercial documents. But it also points out that devices such as smartphones and laptops contain both commercial and private information — and the expectation of privacy in that case is much higher.”
The ruling also underscores the need for the courts to develop a body of guidance that will provide a clear framework for authorities when executing search warrants and seizing materials such as high tech devices, said Ryan. Often times judges do not provide detailed instructions in search warrants to authorities, creating “legally ambiguous and uncertain” situations, added Ryan. Until well-defined boundaries are spelled out by the courts, Ryan believes that the Uber decision will likely make it easier to obtain motions for impoundment.
Granting an order to impound until final judgment is rendered over the challenges to the search warrants would not cause prejudice to the provincial tax authority, said Louis-Frédérick Côté, a Montreal tax litigator who used to work for Revenue Quebec. It is an interim measure that protects the taxpayer.
“The seized material has been in Revenue Quebec’s hands for several months, and we don’t know what they have done with it,” said Côté. “Are civil servants analysing it, perhaps. Have civil servants downloaded material from the devices, perhaps. It is difficult to unread what you have read. That’s why orders to impound are important. In the meantime, the tax authority suffers no harm.”
Taxpayers do not have a general license to “travel back to through time” with the benefit of hindsight to reverse or correct unintended tax consequences of commercial dealings, held the Quebec Court of Appeal in two separate but related rulings.
The rulings effectively limit the scope of the so-called rectification remedy in a tax context under civil law, according to tax experts. A powerful legal instrument, rectification essentially allows taxpayers, under certain conditions, to correct errors in legal documents or instruments that do not reflect the true intention of the parties, and which lead to unintended consequences. Rectification allows the parties to “fix” the terms of the transaction so that the intended tax consequences are achieved. Its effect is retroactive.
Rectification has been available to taxpayers living in common law provinces since the turn of the century, following a decision in 2000 by the Ontario Court of Appeal in Canada (Attorney General) v. Juliar. The SCC turned down the leave to appeal in Juliar.
But following two rulings by the Supreme Canada in Québec (Sous-ministre du Revenu) v. Services Environnementaux AES Inc. and Riopel v. Agence du revenu du Canada that found that it is possible under civil law to rectify an agreement that gave rise to unintended tax consequences, some tax advisors believed they had carte blanche to use rectification to correct tax planning mistakes, noted Étienne Gadbois, the head of the taxation group at De Grandpré Chait LLP in Montreal.
“Following the judgments by the Supreme Court, a lot of people saw this as an insurance policy for advisors working in tax planning,” said Gadbois. “That as soon as they make a mistake in one of their planning’s then it’s not a problem because they could apply to the court and have a rectification order. The Quebec Court of Appeal rulings makes it clear that rectification is not an insurance policy.”
In both cases, Mac’s Convenience Stores inc. v. A.G. Canadaand Canada (Attorney General) v. Groupe Jean Coutu (PJC) inc., the parties maintained that the agreements that they had executed did not reflect their common intention. In the Jean Coutu case, the pharmacy retailer consulted with its accounting experts and examined two scenarios to offset the effects of the fluctuating exchange rate on the value of its U.S. investment on its balance sheet. After opting for one scenario and executing a series of transactions, Jean Coutu achieved its intended purpose of “neutralizing” the effect of the exchange fluctuations. But following an audit in 2010, the Canada Revenue Agency considered the interest income paid to be foreign accrual property income, and assessed the company with $2.2 million of unpaid income tax. The company then wanted to retroactively rectify the transactions according to the second scheme that would reduce the interest payable to nothing.
In the Mac’s case, the convenience store retailer took out a loan for $185 million from an American company. It deducted the interest paid on the loan from its income. A year later, it performed a series of transactions involving several interwoven legal entities, including the payment of a $136 million dividend to its parent company, Couche-Tard Inc. That triggered the application of the so-called thin capitalization rules, which prevented the interest paid under the loan from being deductible which in turn triggered the elimination of over $22 million of interest deduction and assessments for 2006, 2007, and 2008 by federal and provincial tax authorities. Mac’s too sought to remedy the unintended tax consequences by asking the court to replace the declaration of the $136 million dividend by a reduction of its stated capital and the distribution of cash equivalent to the sole shareholder.
“A taxpayer is obliged to pay tax arising from the transaction it effected and not the transaction that it would have preferred to have effected given the benefit of hindsight regarding unintended tax consequences,” held Quebec Court of Appeal Justice Mark Schrager in both rulings. “Taxpayers must live with the consequences of the contract they chose to put in place.”
According to Martin Delisle, a Montreal tax lawyer with De Grandpré Chait LLP, the rulings underscores the dangers of trying to “re-write the tax history” of transactions. “Perhaps since the SCC rulings in AES and Riopel, tax advisors interpreted the notion of rectification too broadly. You cannot rewrite the tax history of what a party in retrospect would have rather done.”
Heeding guidance from the SCC, the Quebec Court of Appeal found that in civil law, the law of contract is premised on the principle of consensualism, and a contract is formed by a “meeting of the minds of the parties.” A distinction is to be drawn, however, between the agreement that the parties intended (negotium) and the declaration – be it oral or written – of that intended agreement (instumentum), noted Justice Schrager. Parties are free to acknowledge a common error and to agree to correct it to what it should have been in circumstances where there was no mistake in the transaction itself but rather a rather a mistake in the way the transaction had been expressed in writing, as long as it does not prejudice any rights acquired by third parties, added Justice Schrager. “Correcting a transaction is not the same as changing it,” said succinctly Justice Schrager. The appeal court concluded that in the Mac’s case there was “no common intention” of the parties because the thin capitalization rules were never contemplated and so it “cannot be the object of a meeting of the minds to which a court can give effect.”
The appeal court came to similar conclusions in the Jean Coutu case, holding that it intended to conduct a series of transaction to neutralize the effect of exchange fluctuations, did so, achieved its objective, and were taxed on that basis even though they did not foresee the tax consequences.
“The two decisions of the Quebec Court of Appeal are important because they provide guidance as to the limitations of the application of the doctrine of rectification in civil law,” observed Louis Tassé, a tax litigator with Couzin Taylor LLP in Montreal. “The Quebec Court of Appeal considerably narrowed the application of rectification in civil law and declined the possibility of substituting a transaction with another, as is possible under the common law doctrine of rectification.”
The appeal court also putd to rest the perception that it is necessary to go before the courts to seek rectification. While the courts can intervene to declare the amendments legitimate and necessary by way of the motion for rectification, Justice Schrager said that parties have the power to correct the documents without the intervention of the court. But that is not something that tax lawyer Alexandre Dufresne would advise clients to do.
“In most cases, even if you don’t have to ask for judicial rectification, it’s probably appropriate to do so,” noted Dufresne, the managing partner of Spiegel Sohmer’s Montreal office. “It’s a question of getting clarity. You also want to make sure that the tax authorities will be on side or aware of what you are doing. So it’s advisable to bring them into the case as interveners. Otherwise you run the risk that the tax authorities will contest it down the line.”
An ambitious international effort calling for a coordinated approach to rewrite global tax rules over profit shifting risks being undermined by the number of growing countries that are unilaterally introducing significant tax reforms, warn tax experts.
The Paris-based Organisation for Economic Co-operation and Development (OECD), backed by the G20 Finance Ministers, proposed in July 2013 a sweeping series of proposals that take aim at aggressive international tax planning by multinational companies in the wake of intense political scrutiny and public outcry over the likes of Apple Inc., Google Inc. and Starbucks moving billions of profits out of higher-tax countries into low or no-tax jurisdictions.
The plan, known as Base Erosion Profit Shifting (BEPS), lists 15 specific actions that will attempt to tackle tax challenges of the digital economy, establish coherent rules for corporate income taxation, prevent tax treaty abuse, increase transparency by taxpayers, and amend the world’s 3,000 bilateral tax treaties through a multilateral instrument. This past February, the OECD and G20 countries agreed to three key elements that will enable implementation of the BEPS project: a mandate to launch negotiations on a multilateral instrument to streamline implementation of tax treaty-related BEPS measures, an implementation package for country-by-country reporting in 2016, and criteria to assess whether preferential treatment regimes for intellectual property – or the so-called patent boxes – are harmful or not. “Most of this has been derived from public reaction over what’s happening with large corporations and their use of international tax rules,” said Angeline Zioulas, CPA, CA, national transfer pricing leader with MNP LLP in Vancouver. “But it’s good tax planning. Most of these companies are public and need to maximize their shareholder wealth. Coming up with efficient tax planning is a good thing overall, and it’s good for shareholders.”
The timetable for implementing the bold and large-scale action plan is set for December 2015, an ambitious schedule that many say is impractical and unattainable. “The BEPS initiative is seeking a degree of coordination that has been unprecedented,” noted Claire Kennedy, a tax lawyer who as an officer of the International Bar Association’s (IBA) Taxes Committee is helping the organization draft responses to the BEPS project. “I am not sure that the OECD is going to succeed in everything that they are aiming to achieve because the project is very ambitious and subject to a very short and unrealistic deadline of what amounts to a reworking of the entire international tax framework.”
The combination of tight deadlines and mounting political and public pressure to address gaps and mismatches in tax rules does not lend itself to an informed and thorough analysis nor a careful balancing of policy objectives, adds Kennedy, a partner with Bennett Jones LLP in Toronto.
On top of that, many countries are not waiting for the OECD to rebuild the international tax system. Instead these countries are using the attention and publicity around the BEPS initiative to adopt interim measures to protect their respective tax bases. Many, for instance, are introducing or enacting anti-avoidance rules. In the lead up to the national election in May, the United Kingdom released the diverted profits tax provisions within its draft Finance Bill 2015. The diverted profits tax is a new tax, charged at 25 per cent on profits that are considered to be “artificially diverted” from the UK. Another European country, Austria, promulgated a rule that denies a deduction for interest and royalties paid to related parties in low-tax jurisdictions. Australia, besides enforcing its existing anti-avoidance rules, released stricter debt funding rules and new transfer pricing guidelines for the practice of assigning prices to goods and services sold between controlled or related legal entities within an enterprise.
“The real tension with the BEPS project and with countries is that fiscal policy is a real critical part of any country’s sovereignty, and countries want to be seen as in their own driver’s seat in terms of developing their own fiscal policy,” said Christopher Steeves, leader of the tax group for Fasken Martineau DuMoulin LLP. “By introducing legislation to show that they are being responsive and reactive rather than waiting for the BEPS project to be completed, that will play with voters.”
Canada nearly joined the list of growing countries acting unilaterally. The Finance Department published a consultation paper on treaty shopping, or the practice of structuring a multinational business to take advantage of more favorable tax treaties available in certain jurisdictions, with the aim of introducing its own plan for a domestic treaty override to combat treaty shopping. “Adopting measures that prevent treaty shopping, as some other countries have done, would protect the integrity of Canada’s tax treaties,” said the consultation paper. But last August, the federal government had a change of heart and quietly shelved its domestic initiative to wait for the BEPS proposals under Action 6 on anti-treaty abuse.
At the same time that countries are tightening tax rules and using aggressive audit tactics such as the Australian Tax Office which is increasingly scrutinizing multinationals through the use of a new special task force or Mexico which is contemplating applying BEPS concepts to previous transactions involving business restructurings, they are also forging ahead and providing tax incentives for multinationals to invest in their jurisdictions, observed Steeves. Patent boxes are a case in point. Designed to attract and nurture research and development companies, patent boxes provide a lower tax rate on profits from work related to patents. “A preferential regime is useful in supporting growth and innovation in a country if it attracts real activity,” said the OECD. “It is not so if it merely encourages companies to shift profits from the location in which the value was actually created to another location where they may be taxed at a lower rate.” Patent boxes have become a sticky point for negotiators involved in the BEPS project. Many countries and organizations like the European Commission view patent boxes as “harmful tax competition,” but the handful of countries that offer it like Britain, Cyprus, and the Netherlands, are resisting pressure from other nations, asserting that it encourages innovation and high-value jobs in research.
“Countries don’t want their tax base eroded but yet they are willing to compete with one another with these various tax plans designed to encourage a company to leave its home jurisdiction and take part of their economy,” said Steeves. “That tension will be a roadblock in some ways for BEPS.”
While governments are supporting various aspects of the BEPS initiative and proceeding on the other hand with preferential tax regimes for certain kinds of income, Kennedy does not believe that those conflicting positions will “per se” sound the death knell of the OECD’s project. “There is a serious question about how BEPS would get implemented in any event,” said Kennedy. “One of the BEPS action items is a multilateral instrument to effect these changes, but I think that is going to be very difficult to pull off given the scope of the changes we are talking about. Almost as a necessity, if there are going to be changes of the nature the OECD is talking about, it’s going to take changes at an individual country legislative level and not one full swoop with this multilateral instrument.”
Business, not surprisingly, are caught in the middle, and are very concerned, said Steeves. When developing cross-border structures, they are asking tax experts such as Steeves to evaluate the proposals and the impact BEPS might have on what they are doing. Given that there is a lot of uncertainty at the moment, Kennedy suggests that business think carefully about their international tax planning. “Business can live with sort of clear rules and regimes,” said Kennedy. “They may be favourable or unfavourable but if they are certain then you can make decisions about investments and business growth.” The uncertainty also makes it challenging for tax advisors, said Zioulas. “It’s a confusing topic,” said Zioulas. “From someone who is living it, and it’s going to affect me and what I do everyday, I absolutely have no idea what’s going to happen. So for us in Canada, it’s wait and see what is going to happen. The best I can do for clients is to say these are things that you need to be aware of when you are conducting your business operations.”