DAVID WILKENFELD, CPA, CA, canadian tax CONSULTANT

Posts Tagged ‘penalties’

Taxpayers Behaving Badly – Part 2

In Business Expenses, Canadian Income Tax on October 29, 2013 at 3:42 pm

In the case of CIBC v R., the CRA disallowed a deduction for expenses solely on the basis that the taxpayer’s conduct was morally reprehensible. The tax court agreed, and The Federal Court of Appeal was asked to rule on this question.

 The issue in this case was the deductibility of $3 billion in payments made by the CIBC to settle litigation in the U.S. relating to the bankruptcy of Enron Corporation. The CIBC was named as a co-defendant in the case, and the settlement was paid to avoid being jointly and severally liable with Enron for its part in the dissemination of misleading financial information.

 In disallowing the settlement amount as a tax deduction, the CRA argued:

 The misconduct of [CIBC and its affiliates] was so egregious and repulsive that any consequential settlement payments […] cannot be justified as being incurred for the purpose of gaining or producing income from a business or property …. The [CIBC affiliates] knowingly aided and abetted Enron to violate the United States’ federal securities laws and falsify its financial statements. The misconduct of [the CIBC affiliates] in enabling Enron to perpetrate its frauds, known to [CIBC], or the misconduct of [CIBC] itself, was so extreme, and the consequences so dire, that it could not be part of the business of a bank.

 If you know your tax history, you will recognize the CRA’s words as stemming from the comments made by the Supreme Court of Canada in the case of 65302 British Columbia Ltd. v. R. In that case, the taxpayer deducted quota penalties it was charged for the over-production of eggs. The quotas were intentionally exceeded in order to maintain a major customer. The court in that case allowed the deduction, but also stated, with regard to penalties in general that:

 It is conceivable that a breach could be so egregious or repulsive that the fine subsequently imposed could not be justified as being incurred for the purpose of producing income.

 In the end, Finance enacted a provision which generally disallows the deduction of any government penalties. But, the CIBC case did not involve penalties, and there is no specific provision of the Income Tax Act that would disallow a settlement payment based solely on the moral conduct of the taxpayer. Indeed, it is a well known fact that income from all sources, including criminal activities is taxable in Canada.

 So, in the end, the Court of Appeal overturned the decision of the Tax Court and did not disallow the deduction solely on the basis of the taxpayer’s conduct. The case will, however, resurface when the time comes to judge whether the deduction should be allowed on its merits as a business expense.

An Unexpected Penalty for Unsuspecting Taxpayers

In Canadian Income Tax on April 10, 2012 at 8:17 pm

My son Victor who is hard at word assisting me with tax returns this year, today learned of a little known penalty that hits many average Canadians who file their returns honestly and in a timely fashion every year. If you’d like to know what it is, just visit his blog.

Thanks for reminding everyone about this Vic. Now get back to work!!

What’s Your Tax Issue: “So-called” Partnership Income

In Canadian Income Tax on November 5, 2010 at 1:30 pm

The Tax Issue:

As a technical salesperson, I was part of a so-called partnership and I received distributions that I was told were not taxable because the partnership was operating at a loss. After a few months, I left the company because the so-called distributions were way below the so-called commissions I was supposed to be getting. In fact they barely covered my sales costs. The fast line is that I was assessed by CRA for unreported income which included penalties and interest. I had no idea of how the accounting was done and I have no history of not reporting my earnings. I am willing to pay the taxes on income but is there anyway to have penalties reduced.

The Answer:

This question raises a number of interesting issues. First, the taxation of partnerships. Without going into a 12-page dissertation, if you were, in truth, a member of a partnership, you would be taxed based on the partnership’s income, not on the distributions made to you.

When you add the words “so-called” to the partnership, it leads me to my next point. Documentation. If you enter into any business relationship, it must be properly documented and accounted for.  If the intention was to enter into a partnership, you should have signed an agreement, and you should have received annual statements indicating your share of the partnership income or loss for tax purposes.

If no partnership existed, then your earnings probably should should have been included in income based on what you received. If the CRA is including these amounts, and you have sales costs that you haven’t claimed, then you should indicate to the CRA that expenses should be deductible to reduce your income.

Finally, let’s talk about these so-called penalties. Unreported income in many cases indicates some level of negligence on the part of the taxpayer. However, in order to apply penalties, the CRA has the burden of proof to show than you were “grossly negligent”. Gross negligence involves intentional acting or an indifference as to whether the law followed. Your story seems to indicate a degree of naiveté, perhaps some negligence, but not necessarily gross negligence. You will have to show that you are credible, and if possible, some evidence that you at least had some reasonable cause to believe that this so-called partnership actually existed.

I would have a discussion with the CRA official and go over these issues, show your side of the story, indicating that you have expenses to claim against the income and show that you were not negligent in believing that you were a member of a partnership.

GAAR Wars: The (Quebec) Empire Strikes Back

In Canadian Income Tax, Tax Avoidance on October 17, 2009 at 3:53 pm

Not Quebec's Finance Minister

The Minister of Finance of Quebec has announced major new rules in the fight against “Aggressive Tax Planning” (“ATP”).

Remember the “Quebec Shuffle”? How about the Alberta-Resident Trust? These and other tax-planning strategies were once all the rage, saving tax dollars by exploiting differences among provincial tax rules. Before they became well-known, they were marketed by tax planners as “confidential” or “proprietary” tax plans, and clients would have to sign non-disclosure agreements before gaining access to these strategies. Often, the fees charged by tax advisors were contingent – based on the value of the taxes saved.

Although the provinces took steps to eliminate many of these plans by introducing specific legislation over the years, and despite the existence of the General Anti-Avoidance Rule (“GAAR”), last January the government of Quebec issued a discussion paper to float proposed rules to further combat ATP transactions.

On October 15, 2009, the Minister of Finance released Information Bulletin 2009-5, which outlines the final version of new rules that will immediately apply to Quebec taxpayers and their advisors.

Mandatory Disclosure

The centerpiece of the proposed legislation is the new reporting regime. These rules are largely based on the U.S. model of “Reportable Transactions”, which has been in place for some years.

In certain instances, taxpayers will now be required to report the details of a transaction (or series of transactions) to Revenue Quebec by the due date for filing their returns. Taxpayers will have to report a complete and detailed description of the facts and the tax consequences relating to the transaction.

There are two categories of transactions that must be reported:

  • Confidential transaction – where the tax advisor has demanded secrecy from the taxpayer regarding the plan; and
  • Transaction with conditional remuneration – where the tax advisor is being compensated based on some form of contingency arrangement. (this would exclude contracts for R&D and other tax credits)

The mandatory disclosure will apply to either of the above types of transactions; however, they will not apply unless the transaction in question results in a tax benefit of at least $25,000 or a deduction of at least $100,000.

Failure to file the information will result in onerous consequences – a penalty of $10,000 plus $1,000 per day up to a maximum of $100,000, as well as suspension of the limitation period for reassessment until the disclosure is filed.

New Punitive Rules Where GAAR Applies

The Minister proposes to extend the limitation period and assess penalties where a transaction is found to be subject to the GAAR.

Firstly, the normal reassessment period (currently 3 or 4 years) will be extended by a full three years. Furthermore, a penalty of 25% of the additional tax will be levied on the taxpayer; and finally, in all cases where GAAR applies, a promoter who markets the plan will be subject to a penalty of 12.5% of the consideration he receives.

Preventative Disclosure

In order to prevent the possibility of an extended limitation period and the penalties in GAAR cases, taxpayers can choose to disclose any transaction to Revenue Quebec on a voluntary basis. If the transaction is reported by the due date of the taxpayer’s tax return, then the application of the GAAR will not come with the extension of the limitation period for reassessments and the above penalties will not be imposed.

New Administrative Department

I suspect that the government will quickly become inundated with disclosures, especially since now, any over-zealous tax auditor could decide to extend the reassessment period by simply pulling out the “GAAR” card (an over-zealous tax auditor in Quebec? Dave, you can’t be serious!).

To this end, the government has established a division of Revenu Québec, called the Direction principale de la lute contre les planifications fiscales abusifs (hooray! another Quebec bureaucratic department!), where all of the disclosures must be sent, on a prescribed form, separately from tax returns .

Quebec has taken a bold step in the fight against tax avoidance. One wonders how long it will be before the federal rules follow suit.