DAVID WILKENFELD, CA, canadian tax CONSULTANT

Archive for August, 2009|Monthly archive page

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Payments to Non-Residents

In Canadian Income Tax, Non-residents on August 31, 2009 at 12:13 pm

Regulation 105 of the Income Tax Act (“the Act”) provides that all taxpayers must withhold 15% from any payment to a non-resident in consideration for services rendered in Canada. In addition, if the service is rendered in Quebec, a further 9% must be withheld and remitted to the Ministére du revenu. Amounts withheld must be remitted to the two governments by the 15th day of the month following the payment. These withholding rates are not reduced by any tax treaty.

For anyone who has chosen to remain ignorant of this requirement, I need only to point to the previous post in this series to prove that the CRA finds the “Global Economy” a very interesting topic and has various tools to check up on non-compliance. For example, in form T106, and on the corporate income tax return form T2, schedule 29, taxpayers are asked to identify payments made to non-residents that may be subject to withholding.

You must withold 15% from non-resident contractors

You must withold 15% from non-resident contractors

Ignorance may be bliss, but it won’t shelter a taxpayer from the significant penalties and interest that may be levied under the Act for failure to withhold. The penalties include $2,500 per failure, on top of an additional 10% of the tax, or 20% if the failure is attributable to gross negligence.

Who are these non-residents providing services to Canadians? They could be employees of a non-resident company, or self-employed individuals that provide any type of service such as consulting, installation or selling services to the Canadian taxpayer.

Whether the payee is subject to Canadian income tax at all is not of any concern to the payer. The non-resident must comply with Canada’s tax laws, and the regulation 105 withholding is a way for the CRA to ensure that that happens. In addition, from the payee’s point of view, any non-resident corporation carrying on business in Canada must file a return, subject to penalties for non-compliance, regardless of whether it is exempt from Canadian tax under a treaty.

In order to recover the taxes withheld, the non-resident must file a Canadian income tax return. If he is not taxable in Canada by virtue of a tax treaty, he will receive the full amount of the withheld tax as a refund. Of course, this is of little comfort to those with cash flow concerns.

The only way to avoid the withholding is for the non-resident to apply for a waiver. The application must be made at least 30 days prior to the payment, and it is a difficult process, with the requirement to show that a treaty does, in fact apply to eliminate the non-resident’s Canadian tax liability. Alternatively, the waiver application could ask that the withholding be based on the net income earned after any deductible expenses.

Regulation 105 is yet another tool to be wielded by the CRA to ensure compliance. Canadian payers caught unaware, may be forced to pay the price on behalf of their non-resident suppliers.

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Canada Revenue Agency tries the Double-Dip

In Canadian Income Tax, Non-residents on August 26, 2009 at 8:45 pm

Who can resist the double dip? Apparently not the CRA.

Once in a while a case comes along that makes me wonder what they’re smoking over at the Appeals Division. In the case of Stora Enso v. The Queen the CRA taxed the same payment twice. Not surprisingly, the Tax Court held against them.

The case deals with Regulation 105 withholding. Anyone paying a non-resident person a fee in respect of services rendered in Canada must withhold 15 per cent of such payment. This regulation is in place to ensure that if a non-resident does business in Canada, the CRA doesn’t have to send their agents around the globe to enforce the law. The key thing to remember here is that it doesn’t matter who the parties to the actual payment are. The withholding requirement applies to any payment in respect of services rendered in Canada by a non-resident, regardless of who pays and who gets paid.

With that in mind, in this case, the CRA went a bit too far. The facts are simple. A Canadian company (Canco) hired a Swedish consulting firm (Swedco). Instead of Canco paying Swedco, a related company (Sisco) chipped in to settle the bill. Canco then reimbursed Sisco.

Some time later, during an audit, the CRA noticed that Canco made a payment to Sisco in respect of a service rendered by Swedco, a non-resident. Since Reg. 105 applied, Canco remitted the 15% to the CRA. But the story does not end here.

The CRA then assessed Sisco for 15% of the amount it paid to Swedco in respect of the same service. Defies logic, right? Well, that’s precisely what the Tax Court said, and decided in favour of Sisco.

Two other noteworthy points came out of this case. First, when Canco made its remittance, it simply calculated 15% of the amount paid to Swedco. However, the tax itself was also considered part of the payment to Swedco, as it was ostensibly paid on account of Swedco’s Canadian tax liability. So Canco was assessed correctly for 15% of the 15%  tax remittance.

And finally, the Court commented on the application of the withholding tax on payments for “out-of-pocket” disbursements. Since such amounts were not itemized on Swedco’s invoice, they could not be distinguished clearly and so the 15% applied. Where an amount paid is clearly in respect of disbursements, however, and not the services rendered, the tax does not apply.

Anyhow, all of this begs the question I’m sure you are all asking: What is this Regulation 105 withholding tax all about, and why should you care? Stay tuned.

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UBS, IRS, CRA and YOU

In Canadian Income Tax, Tax Avoidance on August 23, 2009 at 9:26 pm

What’s all this commotion about UBS? Well if you’ve been out of the loop or simply hiding your head in the sand every time you hear those initials, then it is now officially time to wake up.

First, a bit of background. Around a year ago, a former UBS banker named Bradley Birkenfeld came forward to report illegal tactics by the giant Swiss Bank. UBS was luring big money investors to deposit undeclared income in their bank with promises of the famous Swiss secrecy laws. Birkenfeld was a party to a deposit of $200 million by U.S. billionaire Igor Olenicoff, who was convicted, and required to pay $53 million in taxes and penalties.

The IRS is looking into peoples affairs

The IRS is looking everywhere for offshore bank accounts

The IRS pulled a bit more on the thread. They discovered that a special office over at UBS would regularly make trips to North America to lure big time investors. A part of this office was known as the “Canada Desk”. It is estimated that Canadian investors have deposits of more than $5 billion at UBS.

Why all the Fuss This Week?

The IRS has been trying to get UBS to disclose more names and until last week, has been stonewalled by the bank, who claims it would run afoul of Swiss secrecy laws. On August 19, the Swiss government agreed to loosen those laws in order to cooperate with the IRS. As a result, UBS is now required to hand the names of 4,450 of its biggest U.S. depositors to the IRS.

And it’s only the beginning. In IRS commissioner Doug Shulman’s words “This issue is not going away, and people hiding assets and income offshore will find themselves increasingly at risk due to our efforts in this area.”

What about us poor folk north of the border?

The CRA is chasing after this gravy train like a dog after a truckload of Gravy Train. Revenue Minister Jean-Pierre Blackburn is in a tizzy over Canada’s weak enforcement laws and is recommending major changes to the law to help trace the movement of funds offshore. Lawyers for the CRA are reportedly heading off to Switzerland for “discussions” with UBS officials.

From a Canadian perspective none of this seems to have hit home just yet. To date only seven people have come forward to report their offshore activities. But if more taxpayers intend to do so, they shouldn’t wait too long. The voluntary disclosures program in Canada is designed to give some relief to taxpayers who come forward prior to being investigated. So, if a name is divulged to the CRA and an investigation ensues, no relief will be available.

What kinds of consequences do Canadians face? Tax evasion can come with a two-year prison sentence and fines of more than 50 percent of the tax owing, plus interest compounded daily. Canadian taxpayers are required each year to report their offshore deposits if they exceed $100,000. Failure to file this form can lead to fines of up to $24,000 per year.

Americans have a quick decision to make. The IRS has set up a special framework for voluntary disclosures relating to offshore activities, but this framework has a short life span. If they do not come forward by September 23, taxpayers may face the full force of the law, including possible criminal charges. Here in Canada, the problem is not so urgent, but now would seem to be a good time to think about getting your ducks in a row.

Oh, and one more thing – if you are a professional advisor, you should be aware that our friend, Mr. Birkenfeld was sentenced to 3 years in prison for setting his client up with his UBS account. So don’t say I didn’t warn you.

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Salt in the Wounds?

In Canadian Income Tax on August 13, 2009 at 10:44 am

If Charles Ponzi could see us now. The recent news reports of multiple Ponzi schemes and their unfortunate victims has me worried from a tax perspective.

Maybe I’m being paranoid, but then if you think the CRA would have any sympathy for any taxpayer, under any circumstance, well, let’s say I wouldn’t rely on it. Still….would the Minister of Revenue go so far as to disallow the losses incurred by victims of Earl Jones and the like? Impossible? I wonder.

Generally, when a taxpayer invests his funds, he expects to earn income from property. This expectation is reasonable, and it is the basis upon which one is allowed to take deductions such as related interest and management fees. It is also the reason why, if a loss is incurred on an investment such as stocks and mutual funds, it is generally deductible as an allowable capital loss. Accordingly, you would think that the investors who have come away with little or none of their money as a result of being defrauded in these schemes would at least benefit from the capital losses incurred.

I really hope I’m wrong here, but the jurisprudence in this area is troubling to say the least.

Let’s start with the leading case on the topic. In Hamill v. Her Majesty the Queen (2005 DTC 5397), William Hamill was defrauded. He entered into a scheme whereby he would purchase “precious gems”, and then, through a broker, sell them for huge profits. Unfortunately, the broker turned out to be less than trustworthy, milking the taxpayer for fees at every turn, while the gem sales kept mysteriously falling through. Around two million dollars later, the taxpayer sought to claim his losses for tax purposes.

Both the Tax Court and the Federal Court of Appeal disallowed the losses, and the reasoning is most disturbing. The court stated that “a fraudulent scheme from beginning to end or a sting operation, if that be the case, cannot give rise to a source of income from the victim’s point of view and hence cannot be considered as a business under any definition”.

The court goes on to state that “this is not a case where the Court must have regard to the taxpayer’s state of mind, or the extent of a personal element in order to determine whether a certain activity gives rise to a source of income under the Act”.

Based on the above reasoning, regardless of whether the victim of the fraud was aware he was being scammed, and regardless of the intention of the victim to enter into a profit-motivated transaction, the mere fact that he was a victim of a fraud from beginning to end was enough for the court to disallow the deductions.

The Court of Appeal’s comments are slightly different than those of the Tax Court judge. At the lower level, the court made it clear that Mr. Hamill’s bad judgment was a factor in his demise. The court states that he did not do his homework and “he became a willing victim from the beginning”. This statement leads one to imagine to what extent a taxpayer must do “homework” before he is considered prepared or even intelligent enough to make a business or investment decision.

Perhaps even more disturbing is that the Court of Appeal did not factor this bad decision-making into its decision. Providing a more objective test, the mere fact that the activity constituted a fraud from the beginning was enough to strip it of its eligibility for tax relief.

All of this would be nothing more than mildly entertaining tax reading (albeit not for Mr. Hamill) if it was an isolated case based on a narrow set of circumstances; however, Hamill is not an isolated case. Victims of Nigerian email scams (2008 DTC 2001) and fraudulent partnership schemes (2006 DTC 6199) have suffered similar fates at the hands of the Court of Appeal.

Where does all this leave us with the Canadian victims of the modern day Ponzi disciples? I’m slightly worried. The Income Tax Act disallows the deduction of capital losses where an investment is not made for the purposes of earning income from a business or property. If the rational in Hamill is followed, then any victim of a fraud, where the monies were never invested in any income-producing vehicle could be denied a deduction for income tax purposes, in addition to the loss suffered at the hands of the crooks.

Could the CRA be so cruel????