It has been more than a year since the COVID-19 pandemic (the “Pandemic”) transformed Canadians’ personal and professional lives. As governments, businesses and individuals around the world contend with its crippling economic effects, the uncertainty brought by the Pandemic continues to affect both taxpayers and tax advisors. In Canada last year, the federal government and provincial governments announced new programs weekly (or sometimes daily) to support Canadian individuals and commercial enterprises. Change and interruption were constant, and adaptation became a necessity. This had significant impacts on the tax dispute process in Canada.
This blog will provide our insight into and opinions on some of the general tax dispute trends that we think Canadian taxpayers can expect in the near future.
EFFECTS OF THE PANDEMIC ON THE TAX DISPUTE PROCESS
For the Canada Revenue Agency (“CRA”), the Pandemic meant the suspension of most of its audit activities in 2020. The Tax Court of Canada (“Tax Court”) cancelled all of its sittings for several months of 2020, and most of its sittings from January 2021 to March 2021, and has scheduled a reduced number of in-person Tax Court sittings in select cities from March 29, 2021 to July 16, 2021. Nevertheless, we continued to see some audits undertaken by the CRA related to:
- Canada Emergency Wage Subsidy (CEWS) claims;
- Large corporations in connection with aggressive tax planning arrangements, partnerships and trusts; and
- The real estate sector in Toronto and Vancouver.
With all of the change and interruptions resulting from the Pandemic, it is difficult to predict when we can anticipate a return to “normal” for tax disputes in Canada.
BACKLOG OF TAX DISPUTES
With the postponement of audit activity and the cancellation of Tax Court sittings, there will be a significant backlog of matters within the tax dispute system for a number of years. Both the CRA and the Tax Court have acknowledged that significant delays should be expected for the foreseeable future.
INCREASED RELIANCE ON TECHNOLOGY
One positive effect on the tax dispute process that has come out of the Pandemic is the increased reliance on technology, both from the CRA and the Tax Court. The CRA has started providing taxpayers, in certain circumstances, with the option to send information via email, and also offered virtual meetings with select divisions within the CRA and certain virtual educational clinics. The Tax Court hopes to be fully digitized by the summer of 2021 and is working towards being able to hold trials entirely by video conference.
INCREASED RELIANCE ON SETTLEMENT
The pressures to address the backlog of issues will also likely place greater emphasis on settlement at all levels, which has already begun with the introduction of “fast-track” settlement conferences by the Tax Court. This should be welcomed by taxpayers looking to avoid the lengthy tax dispute process.
MORE EMPHASIS ON REVENUE GENERATION
In 2020, due to the disruption to the economy caused by the Pandemic and the federal government’s responsive attempts to stabilize the Canadian economy, the federal government incurred record deficits of $381.6 billion. According to the International Monetary Fund (“IMF”), Canada accumulated more debt in 2020 than any other industrialized country by borrowing 19.9% of its GDP, which was 46% higher than the average (9.3%) of all other 35 industrialized countries that are part of the IMF. It is expected that these large government deficits will place more emphasis on revenue generation by the federal government.
The emphasis on revenue generation, combined with some of the current global trends related to taxation, is expected to lead to (and largely has already resulted in) more aggressive actions being taken by tax authorities. In particular, there has been a significant increase in media attention dedicated to tax issues, particularly in light of scandals such as the Panama Papers or the Isle of Man tax plan that were widely publicized. Additionally, there has been a general social movement against income inequality and a perception that the wealthy are not paying their fair share of income tax, resulting in governments dedicating significant resources to tax enforcement and, in certain circumstances, adopting more aggressive assessing positions of taxpayers.
INCREASED AUDIT ACTIVITY BY THE CRA
The Canadian government has committed significant resources to CRA audits and enforcement. For example, between 2016-2018, over $1 billion was committed to combat tax evasion, aggressive tax avoidance and compliance. This was followed by an additional $150.8 million in 2019 and $606 million in the Fall Economic Statement 2020. Canadian taxpayers can expect a combination of:
- The need for revenue generation; and
- The additional resources afforded to the CRA to lead to increased audit and enforcement activities over the next several years, once the effects of the Pandemic have subsided.
The CRA has also stated its intention of:
- Hiring additional auditors focused on offshore compliance and avoidance; and
- Developing expertise in emerging industries such as crypto currency and e-commerce.
These initiatives will also stimulate additional audit and enforcement activity in the foreseeable future.
INCREASED FREQUENCY OF DERIVATIVE ASSESSMENTS
Given the economic effects of the Pandemic on individuals and businesses, it is expected that there will be an increase in “derivative” assessments by the CRA. Both the Income Tax Act (Canada)1Income Tax Act, RSC 1985, c 1 (5th Supp). (“ITA”) and the Excise Tax Act (Canada)2Excise Tax Act, RSC 1985, c E-15. (“ETA”) provide rules that impose liability on a third party for the underlying tax debt of another taxpayer (often referred to as “derivative” assessments).
One such provision is section 160 of the ITA. This provision provides the CRA with extensive power to collect delinquent taxes from third parties when, for example, property is transferred from one related taxpayer to another, when the transferor has an outstanding tax liability.
Section 160 applies when the following conditions have been met:
- The transferor is liable to pay tax under the ITA at the time of transfer;
- There must be a transfer of property;
- The transferee must be non-arm’s length with the transferor; and
- The fair market value of the transferred property must exceed fair market value of the consideration given by the transferee.
Although there are defences to a section 160 assessment, the provision is often referred to as a “draconian” or “cruel” provision. It is irrelevant for the application of section 160 whether parties had any knowledge or intent of frustrating the CRA’s collection efforts. In addition, unlike certain other derivative assessment provisions in the ITA and ETA (e.g., director’s liability), there is no due diligence defence for the transferees (the recipient) of the property.
In recent years, the frequency that we have seen section 160 assessments before the Tax Court has increased. Given the dire economic circumstances of many Canadian businesses resulting from the Pandemic, it is expected that this trend will continue and could increase in the years to follow.
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- 1Income Tax Act, RSC 1985, c 1 (5th Supp).
- 2Excise Tax Act, RSC 1985, c E-15.