SCC Update on Tax Rectification – Toronto Tax Lawyer Analysis – Part II

Part I of this article provided background on the doctrine of rectification and how it is used in the Canadian tax context. This part II will review the facts of Canada (Attorney General) v. Fairmont Hotels Inc. and the decisions made by the lower courts.

Facts – Canada (Attorney General) v. Fairmont Hotels Inc.

In 2002, Fairmont Hotels and its subsidiaries assisted Legacy Hotels REIT in financing the purchase of two hotels in the United States through a reciprocal loan arrangement. Since the financing was to be done in US currency, Fairmont was concerned about tax liability that could arise from changes in the exchange rate. As a result, the transaction was structured to achieve foreign exchange tax neutrality. This was achieved by ensuring that any loss from foreign exchange fluctuations would be offset by a corresponding gain and vice versa. If you are concerned about the tax implications of foreign exchange fluctuations on your business, consider reaching out to one of our top Toronto tax lawyers.

In 2006, Fairmont Hotels was acquired by Kingdom Hotels International and Colony Capital LLC. This acquisition threatened to cause Fairmont Hotels and its subsidiaries involved in the reciprocal loan arrangement to realize a deemed foreign exchange loss without the corresponding gains. That would compromise the ability of the structure to provide foreign exchange tax neutrality. Fairmont responded to this by executing a plan that fixed the problem for Fairmont itself, but deferred solving the problem for its subsidiaries until a later date. If you are involved in the purchase or sale of a business and would like to know more about tax traps and planning opportunities, please contact one of our experienced Toronto tax lawyers.

In 2007, Legacy Hotels REIT decided to sell the hotels and requested on short notice that Fairmont unwind the reciprocal loan agreement. Fairmont proceeded to do this without realizing that since they never fixed the foreign exchange tax neutrality problem for the subsidiaries, they would face adverse tax consequences. The Canada Revenue Agency uncovered this fact as part of the tax audit of Fairmont’s 2007 tax returns. Fairmont then applied to the court to rectify the director’s resolutions they used to unwind the reciprocal loan agreement so as to maintain the foreign exchange tax neutrality the structure was originally designed to ensure.

Judicial History – Canada (Attorney General) v. Fairmont Hotels Inc

The Ontario Superior Court of Justice found in favour of Fairmont Hotels. The Superior Court found that Fairmont a continuing intention to maintain foreign exchange tax neutrality and that Fairmont did not have a specific plan as to how they would achieve that outcome. Relying on Juliar v. Canada (Attorney General), the Superior Court found that it was not necessary for Fairmont to have a specific plan in mind to qualify for rectification. The Superior Court took the position that Fairmont’s continuing intention to maintain foreign exchange tax neutrality meant that their rectification request was not an instance of retroactive tax planning and that denying Fairmont’s application would give the Canada Revenue Agency an unintended gain.

The Ontario Court of Appeal also found in favour of Fairmont Hotels. The Court of Appeal found that the critical component for rectification is the continuing intention to undertake a transaction on a specific tax basis. According to the Court of Appeal, rectification does not require the parties to know the precise mechanics or specific means by which they would achieve their intended tax result so long as the intention to achieve that tax result can be demonstrated. Please continue to part III of this Toronto tax lawyer tax rectification article which will discuss the Supreme Court of Canada’s decision and its implications for taxpayers.

Read previous part of this article SCC Update on Tax Rectification Part 1.

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SCC Update on Tax Rectification – Toronto Tax Lawyer Analysis – Part II

Tax Rectification – Toronto Tax Lawyer Analysis – Part I

Tax rectification is a remedy that can be sought when a legal document fails to reflect the tax intent of the parties to that document. When granted the court will retroactively alter the text of the document to reflect the original intentions of the parties. Rectification has been used extensively for the purposes of fixing tax problems by having the court alter the documents which gave rise to the mistake. It should also be noted that although the parties to an agreement can agree to amend the agreement, that amendment is not effective retroactively against the CRA unless an order from the court granting rectification is obtained. If you have a tax problem, please contact one of our experienced Toronto tax lawyers to discuss if rectification may be available to provide you with tax help.

The key tax rectification case until Fairmont Hotels was Juliar v. Canada (Attorney General), where the taxpayer was involved in reorganizing a family business. The taxpayer was a party to a written agreement that exchanged shares for promissory notes. The parties had intended for the transaction to occur on a tax deferred basis, but it turned out that the value of the promissory notes exceeded that of the shares, which resulted in a deemed dividend. If the taxpayer had proceeded by way of a share for share exchange then the transaction would have been completed on a tax deferred basis. The taxpayer then successfully applied to the court to rectify the transaction by altering the written agreement so that it was a share for share exchange on the grounds that the original written agreement failed to reflect the parties’ intention for the transaction to proceed on a tax deferred basis. Our expert Toronto Tax Lawyers can help in properly implementing a tax reorganization.

Canada (Attorney Genera) v. Fairmont Hotels Inc., the Supreme Court of Canada’s latest decision on rectification, is a significant development because it narrows the scope of when taxpayers can ask the court for rectification. Court orders for rectification will no longer be available in situations similar to Juliar v. Canada (Attorney General). Despite this, there is still room for the doctrine of rectification to be relevant in the Canadian tax context. In light of this decision, taxpayers will need to adopt new strategies both to avoid the need for rectification orders and to be able to obtain one if necessary. If you would like to learn more about how to respond to the Supreme Court of Canada’s decision, please contact one of our experienced Toronto tax lawyers.

Part I of this article provided background on the doctrine of rectification and how it is used in the Canadian tax context. Part II will review the facts of Canada (Attorney General) v. Fairmont Hotels Inc. and the decisions made by the lower courts. Part III will discuss the Supreme Court of Canada’s decision and its consequences for taxpayers going forward.

Read the next part of this article by clicking on SCC Update on Tax Rectification.

Tax Rectification – Toronto Tax Lawyer Analysis – Part I

CRA Update to CRA Tax Collections Information Circular IC98-1R6

CRA updated its tax collections information for taxpayers, IC98-1R6, which is the sixth revision of this Information Circular. The changes reflect the new rules for interest relief as a result of implementation of the Court of Appeal decision in Bozzer v. Canada (2011 FCA 186). Although the policies have not changed, it is helpful to remember the rules relating to payments of amounts or security that has been granted in respect of a tax assessment that is disputed with a Notice of Objection or an appeal to the Tax Court of Canada. If CRA Appeals has not confirmed or varied an income tax assessment within 120 days a Canadian tax lawyer can apply for the return of all amounts paid, or the release of any security provided for the tax in dispute.

CRA Update to CRA Tax Collections Information Circular IC98-1R6

Recent Fiscal Arbitrators Gross Negligence Penalty Appeals and the Concept of Wilful Blindness

Four Tax Fraud Cases Involving Fiscal Arbitrators Released

Four judgments on cases involving tax fraud through false statements on tax returns have recently been released. Each case is an appeal of the assessment of a gross negligence penalty by the Canadian Revenue Agency (“CRA”) against the taxpayer. In all cases, the taxpayer used a tax preparer from Fiscal Arbitrators or a tax preparer associated with Fiscal Arbitrators to prepare their returns. All returns were later found to contain blatant misstatements. Despite the obviously false statements contained in their returns, in three cases, the taxpayers won and the gross negligence penalties were deleted. In the final case, the gross negligence penalty was upheld. This Canadian tax law firm article will summarize the facts of each case and highlight factors that may lead to success or failure in gross negligence penalty appeals and, in particular, what is necessary to eliminate penalties related to Fiscal Arbitrators and DSC Lifestyle Services.

Canadian Gross Negligence Penalties

The income tax system in Canada is both self-reporting and self-assessing. As such, it relies on the honesty and integrity of taxpayers in order to function effectively. Taxpayers have a duty to report their taxable income completely and correctly, regardless of who prepares the return, as the success of the Canadian income tax system is dependant on taxpayer compliance and truthfulness. In order to induce taxpayers to disclose their income, and to penalize the ones who don’t, CRA conducts tax audits and the Income Tax Act (the “Act”) allows the CRA to assess penalties for failure to file under section 162 and to assess penalties for false statements under section 163.  The penalty provisions under the act, especially the gross negligence penalties for misstatements, are quite serious since they amount to tax fraud. We recommend that you consult our experienced Canadian tax lawyers if you have been assessed penalties under section 162 or section 163 of the Tax Act.

Under section 162(1), the failure to file penalty is calculated in two parts. First, 5% of tax payable that was unpaid when the return was required to be filed is assessed. Second, 1% of unpaid tax payable is multiplied by the number of complete months that pass between the required dated of filing and the actual date of filing (up to a maximum of 12 months). Under the repeated failure to file penalty in section 162(2), the percentages are doubled to 10% and 2% respectively and the number of months that the penalty can be applied to increase to 20 from 12. Under section 163(2), a misstatement penalty is often assessed at the greater of $100 or 50% of the amount of tax that was avoided as a result of the misstatement.

Fiscal Arbitrators & DSC Lifestyle Services

The modus operandi of Fiscal Arbitrators was to entice taxpayers with the promise of a large refund. In exchange, Fiscal Arbitrators would charge a fixed fee for the preparation of the return in addition to a percentage of any refund obtained. Fiscal Arbitrators generated the refunds by claiming fabricated business losses and using carry back rules to refund taxes previously paid by the taxpayer. DSC Lifestyles Services was also involved in the scheme and would refer their clients to Fiscal Arbitrators for a cut of proceeds. According to reports on CTV’S  W5, as many as 1,800 Canadian were involved in the Fiscal Arbitrators program.

Fiscal Arbitrators Gross Negligence Penalties Cases Fact Summaries:

In all of the cases below, the taxpayer committed tax fraud by falsely claiming a large fictitious business loss as per the advice of Fiscal Arbitrators which, if allowed, would result in a refund to the taxpayer of taxes withheld at source for the year filed. In addition, the taxpayer also signed a “Request of Loss Carryback” to apply the business loss to prior taxation years. All of the taxpayers were assessed gross negligence penalties.  In no cases did they consult with a Canadian tax lawyer before submitting their returns.

Anderson & The Queen [2016 TCC 93](“Anderson”): In 2008, the taxpayer claimed a business loss even though his only income was from employment. The taxpayer was born in 1955, was unmarried, was without children, and dropped out of school at the age of 15. The taxpayer worked odd jobs until he was employed at Canada Pacific Railway (“CPR”) where he worked for 36 years. The taxpayer had no tax or accounting education. The taxpayer had never prepared a tax return himself. His mother, tax preparer’s and friends had helped him file up until the 2008 taxation year. In 2008, the year at issue, the taxpayer had his return prepared by Mr. Muntaz Rasool. The taxpayer met Rasool through a co-worker in 2006. Rasool would frequently promote programs to employees of CPR which would generate refunds for the filers. The taxpayer believed that Rasool was an experienced person in tax matters since others at CPR had dealt with him without issue. Rasool was also able to produce credentials such as reference letters as well as a business card stipulating that he had an accounting designation. The taxpayer invested in programs endorsed by Rasool in 2006 and 2007 and received refunds. In 2008, the taxpayer hired Rasool to prepare his return. The taxpayer was presented his return and signed were indicated but, he inquired about why the refund was so large. Rasool’s rationale was that he had special knowledge of the Act. At trial, the Taxpayer testified that he word “per” in front of his signatures, which was included on the filed return, had been added without his knowledge and that certain pages regarding the business loss and loss carryback were also added. When reviewing his return, the taxpayer did notice that the tax preparer box was blank and added Rasool’s information. This upset Rasool. The taxpayer paid Rasool a portion of the refund he received. The taxpayer requested a copy of the return from Rasool and was refused. The taxpayer was later contacted by the CRA for a tax audit regarding the alleged business that had produced the loss. The taxpayer provided the correspondence from the CRA to Rasool who later disappeared. The taxpayer did not send any letters drafted by Fiscal Arbitrators to the CRA.

Morrison & The Queen [2016 TCC 99 ](“Morrison”): The CRA assessed a tax penalty against the taxpayer for the 2008 taxation year for his tax fraud. The taxpayer was from a small town. The taxpayer was put into contact with a tax preparer through a friend whom he had known for over 30 years. His friend had received a substantial refund without issue. The taxpayer was a car salesman and had filed his own returns for 40 years. The tax preparer presented him with a T1 adjustment and the taxpayer signed where indicated. Pages were later added to the return after it was signed. The T1 adjustment did reference a “business loss;” however, the taxpayer only turned his mind to the fact that if he overpaid tax for 5 years and was refunded for all those amounts, a substantial refund could be produced. The CRA conducted a tax audit inquiring about the business loss. The taxpayer contacted his preparer and the preparer responded with a “nonsensical” letter which the taxpayer refused to sign. The taxpayer then filed a Notice of Objection. The taxpayer cooperated with the appropriate investigative division.

Sam & The Queen [2016 TCC 98 ](“Sam”): The taxpayer had her returns prepared for many years by her sister-in-law Denise Hunt. Denise had a university background in accounting and the taxpayer had received refunds for many years due to the deduction of union fees and RRSP contributions. Denise worked for an accounting corporation named DSC for six years until her death in 2010. The taxpayer went to the DSC office in order to have her 2009 return prepared. The taxpayer was referred to Fiscal Arbitrators. When the taxpayer inquired as to the identity of that individual, she was told not to worry as the person had done thousands of returns. The completed return was delivered back to DSC for the taxpayer to sign. The taxpayer looked at the return briefly and signed the return and the loss carry back form. When the refund did not arrive the taxpayer was referred to Larry Watts of Fiscal Arbitrators who provided her with “nonsensical” letters to send to the CRA. The taxpayer sent the letters. The taxpayer believed she was getting valid advice. The taxpayer was not pitched to specifically hire Larry or Fiscal Arbitrators for the purposes of obtaining a refund.

Sledge & The Queen [2016 TCC 100 ](“Sledge”): The Taxpayer was 45 years old, was born in Texas, and does not have any post secondary education. The taxpayer is a former US Navy sailor and was subsequently employed in Canada as an Operations Manager for FedEx. Ten years prior to the appeal the taxpayer met Lloyd at a barbershop. The taxpayer does not know Lloyd’s last name. The two became friends and spoke about income taxes. Prior to 2008, the taxpayer had his return prepared at H&R Block. Lloyd told the taxpayer about a company called Fiscal Arbitrators. Fiscal Arbitrators represented themselves as professional tax preparers. They would recalculate taxes over a 10 year period in order to obtain a refund for taxes overpaid in previous years. The taxpayer met Lloyd’s sister who endorsed the company. The taxpayer was still concerned about legality, but Lloyd assured him they were just like H&R Block. The taxpayer retained Fiscal Arbitrators and provided Lloyd with his T4’s for the previous ten years. Once prepared, the taxpayer did not review his return and simply signed where indicated. The taxpayer did not see that the identification box for tax preparers was left blank. The taxpayer testified that he did not look at the numbers on his return and also testified that he did not look at the refund amount he was claiming. The taxpayer did not ask any question regarding the contents of the return. The CRA later contacted the taxpayer in a tax audit questioning the business loss. The taxpayer contacted Lloyd. The taxpayer was referred to Larry Watts from Fiscal Arbitrators who provided the taxpayer with nonsensical letters to send to the CRA. The taxpayer later reached out to the CRA as the letters drafted by Watts did not address his situation. The CRA did not issue a refund and disallowed the business loss, denied the carryback and imposed a penalty. The taxpayer objected to the assessment, the CRA confirmed the assessment so the taxpayer appealed to the Tax court with a Canadian tax lawyer.

Appealing Gross Negligence Penaltiess

In order be assessed a penalty under section 163 of the Income Tax Act (“The Act”) the CRA must prove that (1) the taxpayer made a false statement or omission in their income tax return, and (2) that the statement or omission was either made knowingly, or under circumstances amounting to gross negligence. Thus, penalties assessed under section 163 are often referred to as gross negligence penalties.

In each of the above cases, it was overtly obvious that the taxpayers had committed tax fraud by having made false statements in their income tax returns. Each taxpayer claimed a business loss for a business that did not exist. The true issue in these cases was whether the CRA could prove that the misstatement was made knowingly, or whether the taxpayer was grossly negligent.

If the CRA cannot prove that the taxpayer knowingly made a misstatement or omission they will attempt to prove that the taxpayer was grossly negligent. In Villeneuve v Canada [2014 FCA 20] the Federal Court of Appeal found that gross negligence, for the purpose of the Tax Act, could include “willful blindness”. The Torres et. Al v The Queen [2013 TCC 380] (“Torres”) case succinctly summarizes the general legal principles with respect to wilful blindness in gross negligence penalty cases. The Torres principles, as set out by Justice Miller, were affirmed by the Federal Court of Appeal in 2015. Please note that the Torres principles do not set out an exhaustive list of circumstances that would indicate a need for inquiry.

Torres Principles

  1. Knowledge of a false statement can be attributed to wilful blindness
  2. Wilful blindness can be applied to gross negligence penalties under subsection 163(2) of the Act.
  3. In determining wilful blindness, education and experience of the taxpayer must be taken into consideration.
  4. To find wilful blindness there must be a need or a suspicion for an inquiry.
  5. Circumstances that would indicate a need for an inquiry prior to filing include the following:

              i) the magnitude of the advantage or omission;

            ii) the blatantness of the false statement and how readily detectable it is;

         iii) the lack of acknowledgment by the tax preparer who prepared the return in the return itself;

          iv) unusual requests made by the tax preparer;

          v) the tax preparer being previously unknown to the taxpayer;

           vi) incomprehensible explanations by the tax preparer;

      vii) whether others engaged the tax preparer or warned against doing so, or the taxpayer himself or herself expresses concern about telling others.

        viii) The final requirement for wilful blindness is that the taxpayer makes no inquiry of the tax preparer to understand the return, nor makes any inquiry of a third party, nor the CRA itself.

Common Case Factors

The appeals of the gross negligence penalties by Canadian tax lawyers were successful in Anderson, Morrison and Sam. In each of these cases the gross negligence penalty was deleted. In the Sledge case however, the penalty was upheld.

In each case, the judge examined the conduct of the individual, taking into account their experience and education, to determine if enough “red flags” were raised that would indicate a need to investigate. The more frequently a taxpayer fails to inquire after a “red flag” is raised, the more likely the taxpayer will be found to be wilfully blind.

A key concept as to why Sledge was decided differently is due to the total lack of effort on the part of the taxpayer to verify the accuracy of his return. There is strong support in case law that stipulates that placing blind faith in preparers, without taking at least some steps to verify the correctness of information supplied, will not enable taxpayers to avoid gross negligence penalties. In essence, this all relates back to the idea of the self-reporting scheme where the taxpayer has an obligation to ensure the information supplied in their return is truthful. By placing full reliance on the accountant or tax preparer, the taxpayer is abandoning their obligations under the Act and may be subject to harsh penalties as a result. To certify a return with a signature without even looking at the contents will likely lead to an adverse outcome if obvious misstatements have been made.

In Anderson, more effort was undertaken on the part of the taxpayer to examine the information in their return. The taxpayer met with his tax preparer several times and even went so far as to fill in the tax preparer’s name despite it being purposefully omitted. Inquiries were also made as to why the refund was so large, and a justification was provided to the taxpayer. In stark contrast, in Sledge, the taxpayer testified that he did not look at the numbers on his return, and that he did not see the box provided for the identification of professional tax preparers. When probed about the approximately $281,000 in business losses claimed, the taxpayer admitted that he saw it, but assumed it was a summation of all taxes paid for the previous 10 years. He made no inquiries. Further, the judge did not believe his testimony that he did not look at the large refund amount as generating a refund was the sole purpose for his dealings with Fiscal Arbitrators. In Slegde, the taxpayer’s lack of both effort and credibility led to the upholding of the gross negligence penalties.

Another factor taken into consideration is how the taxpayer came into contact with the fraudulent tax preparer. In Morrison, the fact that the taxpayer had been referred by a friend of 30 years in a small town lessened the “need for inquiry” threshold. In Anderson, the taxpayer also relied on a recommendation from a long time friend. As opposed, in Sledge, the taxpayer could not even recall the last name of the friend from the barbershop who referred him to Fiscal Arbitrators. On a related note, if the tax preparer was able to produce credentials, as Rasool did in Anderson, the need for inquiry may also be reduced.

Whether the taxpayer was “pitched” a refund was also relevant in judicial analysis. In Sam, the taxpayer was referred to a fraudulent agent through a firm her sister had worked at for several years (DSC Lifestyle Services). The taxpayer was not “pitched” a program that would generate a refund. The taxpayer simply returned to the same location as she had in previous years in order to have her return prepared. Further, she had a history of receiving refunds, through legitimate means, which may also have lowered the threshold for a need for an inquiry for the tax year at issue.

How the taxpayer responded to inquiries made by the CRA about the business losses was also considered in the judicial analysis. Cases were decided more favorably where the response letters prepared by Fiscal Arbitrators were not sent to the CRA. In Morrison, the taxpayer read the letters he was provided by Fiscal Arbitrators. The taxpayer then realized that the letter was nonsensical and, instead of sending the prepared response, retained counsel. In Anderson, the letters were not sent because Rasool did not provide them to the taxpayer before he disappeared. In Sam and Sledge, the nonsensical response letters were signed by the taxpayer and were sent to the CRA. While Sam was decided favorably, the taxpayer was found to have “gone wrong” when she sent in the letters; however, the unique circumstances of not being explicitly “pitched” the refund scheme mitigated the damage done to her case by sending the nonsensical letters. As to why these letters were damaging, arguments were made that this type of conduct was indicative of the appellant’s “trust” in the tax preparer. Strong legal precedent exists where “simply trusting” a preparer or “blindly trusting” a preparer, without taking efforts to become informed, may constitute gross negligence.

While many factors were considered, taxpayer efforts with respect to verifying the amounts in their returns and how the taxpayer came into contact with the tax preparer are extremely relevant to these types of decisions. Our experienced Toronto tax lawyers can advise on these CRA gross negligence penalty issues.

Conclusion

As you can see, these types of determinations are fact dependant and take into consideration many different factors and principles. Similar activities carried on by different taxpayers may yield opposite results in gross negligence penalty appeals. It is very much a threshold analysis where the court will take multiple factors into account in order to determine if the taxpayer crossed the line from “carelessness” or “naiveness” into wilful blindness. In summary, what it boils down to is whether a need for inquiry existed in the particular taxpayer’s case, how strong that need was, and how the taxpayer responded to that need. Overall, if there is a significant lack of effort on the part of a taxpayer to verify blatantly obvious misstatements on their returns, like in Sledge, the court will likely uphold the penalty. If you find yourself in a situation where you have been accused of tax fraud or tax evasion and assessed a gross negligence penalty, a discussion with one of our top Toronto Tax Lawyers about your specific circumstances will greatly assist you in your objection and/or appeal process.

Recent Fiscal Arbitrators Gross Negligence Penalty Appeals and the Concept of Wilful Blindness

Employee Stock Options Tax Planning– Vancouver Tax Lawyer Commentary

Employee Stock Options- Introduction

The income tax planning for the structure of a stock option plan requires the income tax law and corporate law expertise that our experienced Vancouver tax lawyers bring to all client tax issues. In a stock option plan, the employee is given or earns the right to acquire shares of the corporation, usually at some fixed period of time in the future. Sometimes the employee acquires certain shares at the inception of the stock option plan with rights to acquire additional shares in the future. The vesting of the stock option rights may be deferred for some period of time and will usually only vest if the individual is still employed by the corporation.

Employee Stock Option Agreement- Requirements

There has to be a written stock option agreement which specifies how the employee earns rights to additional shares, the price to be paid for those shares and requirements for vesting. For privately held corporations continued employment with the corporation is generally a prerequisite for exercising the stock option and for keeping the shares. In the event of a departure from employment, even if the employee is fired, the shares are usually reacquired by the corporation on some basis since a closely held corporation does not want shareholders who may have adverse interests. Our top Vancouver tax lawyers are experienced in tax planning for the structuring and drafting of stock option agreements.

If the shares of the corporation are publicly traded then the employee will generally be permitted to keep the shares even after employment is terminated. However, he or she will generally be unable to exercise stock options to acquire any additional shares after leaving employment with the corporation.

Stock option plans are one of the proverbial “golden handcuffs” since the employee’s rights are limited or terminated in the event of termination of employment, so proper income tax planning and business planning is essential in structuring the terms and conditions of the plan.

Most stock option plans are limited to management but some stock option plans are made available to all employees of the organization. In that case there will usually be a different stock option plan for management and for non-management employees.

Another tax planning advantage to stock option plans from a corporate point of view is that there is no cash outflow to the corporation. On the contrary, if the employees are required to buy the optioned shares at fair market value, the corporation actually receives funds. Payments are only required by the corporation if dividends are declared.

Employee Stock Option Plans- Taxation

The issuance of stock options has Canadian income tax implications that vary depending on whether the corporation is private or public and also depend on how long the shares are held after exercise of the stock option and our Vancouver tax lawyers have the experience to properly advise you.

When stock options are given without a tax reorganization, and a benefit is conferred on the employee, the Tax Act has special provisions that are applicable.

Stock option benefits are taxable as employment income because they are, in effect, an alternative to cash compensation.

The common law rule that stock option benefits arose in the year in which the stock option was granted created considerable uncertainty in determining the value of benefits derived from unexercised stock options. The Canadian Income Tax Act resolves the uncertainty by specifying both the method of valuation and the time for inclusion of the benefit in taxable income.

An individual is taxable on the value of stock option benefits derived by virtue of employment. The benefit is determined by reference to the shares actually acquired pursuant to the stock option plan.

The first question is: Was the benefit conferred by virtue of the employment relationship? Issuance of stock for other considerations (for example, as a gift or in return for guaranteeing a loan) does not give rise to a benefit from employment. The tax definition of “employment” includes employees, and Officers are included in the tax definition of “employees”. Case law supports the idea that a director is an officer of a corporation; therefore, directors are bound by these provisions in almost all circumstances. An exception to this rule occurs when the benefit received by the director was not conferred by virtue of the employment relationship.

The triggering event for the recognition of stock option benefits is the acquisition of shares at a price less than their value at the time the shares are acquired. The time of acquisition is determined by reference to principles of contractual and corporate law.

Except in special cases (discussed below), the value of a stock option benefit can be determined only at or after the time the stock option is exercised, that is, when the shares are acquired. The value of the benefit is the difference between the cost of the option to the employee, any amount paid for the shares, and the value of the shares at the time they are acquired from the plan. Shares are considered to be acquired when the option is exercised.

“Value” means “fair market value”. In the case of publicly traded securities, stock market prices will usually be considered indicative of fair market value. Since listed stock prices inherently reflect the value of minority shareholdings, there is no need to further discount their value for minority interest.

The value of shares of a private corporation, which will be the case with owner-manager entrepreneurs and closely held businesses, is more difficult to determine. Shares of private corporations are generally valued by reference to estimated future earnings and the adjusted net value of assets. The pro rata value of the corporation is then adjusted to reflect a discount for minority interests, lack of market, etc.

When it comes to income tax planning for stock option plans there are two special income taxation rules. One applies to options issued by Canadian-controlled private corporations (“CCPC”) and the other to acquisitions of prescribed equity shares. These rules are incentive provisions intended to stimulate equity participation in Canadian corporations.

Shares acquired from a CCPCs stock option plan in an arm’s length transaction receive preferential treatment if they are held for at least two years. This is so whether the shares are issued by the employer corporation or by another Canadian-controlled private corporation with which the employer does not deal at arm’s length.

An employee may defer income tax recognition of any benefit derived from stock options issued by a Canadian-controlled private corporation until disposition of the shares. CCPC employees are also able to deduct 50% of any stock option benefits received from CCPC’s under s. 110(1)(d.1) of the income tax act on the condition that they have not disposed of or exchanged shares for two years after the acquisition date. Upon disposition of the shares, the employee is taxable on the benefit amount less the deduction and the taxable portion of any capital gains realized on disposition.

The employee benefits by deferring any income tax liability which would otherwise arise upon acquisition of the shares through an “ordinary” stock option plan and by converting what would normally be fully taxable employment source income into income that is, in effect, taxable at a lower rate. The portion of the benefit that is taxable to the employee is not a capital gain but income from employment, taxed at the same rate as a capital gain.

An employee who disposes of shares in a Canadian-controlled private corporation within two years from the date of acquisition is taxable in the year of disposition on the full value of any benefit derived from their acquisition.

There is also a special rule for stock option plans under which an individual acquires prescribed equity shares in an employer’s corporation or in a corporation with which the employer does not deal at arm’s length. Under these special rules, It is also possible to receive a 50% deduction. The benefit, however, is taxable on a current basis.

The following conditions must be satisfied in order for a stock option plan to qualify for this special tax treatment:

  • The shares must be prescribed at the time of their sale or issuance
  • The employee must purchase the shares for not less than their fair market value at the time the agreement was made; and
  • The employee must have been at arm’s length with the employer and the issuing corporation at the time the agreement was made.
    Employee Stock Option Plans- Vancouver Tax Lawyer Assistance

An employee stock option plan can be an important part of a corporation’s compensation package and has benefits to both employer and employee. Tax planning, structuring and drafting such an employee stock option plan requires advice from one of our experienced Vancouver tax lawyers. If you require tax help or advice with your employee stock option plan contact our Vancouver tax lawyer firm.

Employee Stock Options Tax Planning– Vancouver Tax Lawyer Commentary

Requirement to File Income Tax Returns

File Income Tax Returns

Unfiled Tax Returns

The general obligation to file income tax returns is set out in section 150 of the Income Tax Act.

Corporation Income Tax Filings

All corporations resident in Canada have to file T2 income tax returns within 6 months of their year end.  There is no requirement that corporations have a calendar year end. Corporations that are not resident that are carrying on business in Canada or realize a capital gain during the year or dispose of taxable Canadian property also have an obligation to file a Canadian corporate tax return.

Trust and Estate Tax Returns

Trusts and estates have a calendar year end and are required to file T3 income tax returns within 90 days of the year end.

Individual Tax Returns

As a general rule individuals are required to file T1 tax returns by April 30 of each year, however there are exceptions. Individuals with self employment income have until June 15 to file their tax returns. If an individual had no taxable income during the year, there is no obligation to file a tax return unless the individual had a capital gain during the year of disposed of capital property, or unless CRA issues a demand to file a tax return under subsection 150(2).

Offences for Failure to File

Failure To File Offence

Failure to file a return is an offence under subsection 238(1) and is punishable by a fine of between $1,000 and $25,000 plus a possible jail sentence of up to 12 months.  These penalties are applicable for every failure to file and each unfiled year is a separate offence, so failure to file 3 years of returns would be subject to a minimum penalty of $3,000.

Tax Evasion Offence

If CRA can prove that the failure to file the income tax returns was a deliberate attempt to evade the payment of income taxes, they can and do bring tax evasion charges under paragraph 239(1)(d).  The penalties on conviction for income tax evasion are much more severe, with fines of between 50% to 200% of the tax evaded plus possible jail time of up to 2 years.  CRA may also elect to proceed by indictment under subsection 239(2) in which case the penalties increase to between 100% to 200% of the taxes evaded plus possible imprisonment of up to 5 years.

CRA Procedures

Requests and Demands to File Returns

CRA does not generally proceed to bring charges whenever it finds a taxpayer has failed to submit the required tax returns.  CRA’s policy is to encourage compliance with the Income Tax Act.  When they come across a taxpayer who has failed to file tax returns they normally send a request to file the missing returns.  If that request is not complied with then normally a Demand to file under subsection 150(2) is issued.  Only if the Demand is ignored will they proceed to prosecution, usually under 238(1).  When faced with clients being prosecuted with multiple years of unfiled returns our Canadian income tax litigation lawyers  are usually able to negotiate a plea bargain to plead guilty and pay the minimum penalty for just one year by bringing all years into compliance prior to the trial.

Requirement to File Income Tax Returns

Top 3 Canadian Income Tax Stories of 2015 as Determined by Canadian Income Tax Lawyer

Income Tax Collection| Top Tax Story

Looking back on every year there are numerous Canadian income tax developments and changes.  However in deciding on the top income tax stories for the year our Canadian income tax law firm looked for tax related developments that have the potential to affect a large number of Canadian taxpayers.  With this is mind, here are Canadian income tax lawyer picks for top tax stories for 2015.

Fraudsters Impersonating  CRA Collections Officers

The most important income tax story of the year is the Canada wide epidemic of phony phone calls from crooks claiming to be CRA collections officers.  You’ve heard of “phishing” scams where fraudsters try to get you to click on email links that then download malware or spyware on your computer.

But the latest wave of fraud has to do with old-fashioned phone calls made by crooks posing as Canada Revenue Agency (CRA) collections officers telling that you owe more taxes—something that strikes fear into the heart of every Canadian. And fear is the currency of fraudsters. These fraud artists call Canadian taxpayers and threaten imprisonment if immediate payments for back income taxes owing are not made. Payment arrangements using wire transfers, Western Union, prepaid credit cards or even immediate withdrawals from bank ATMs are then made. Thousands of Canadian taxpayers have been contacted, and hundreds of Canadians have been duped into making payments to these criminals in 2015.  Numerous warnings have been issued by CRA, local and provincial police forces and by the RCMP.

The CRA does not demand payment of income tax debts by wire transfer or by any means other than cheque or money order payable to CRA. A tax collections officers will initiate phone calls and may visit a taxpayer’s home or, in the case of corporations, the office however CRA does not jail Canadian taxpayers for unpaid income tax debts. If you have tax concerns and don’t want to contact CRA directly, you can always speak to one of our Canadian tax lawyers who can do so on your behalf.

Income Tax Changes by new Liberal Government

A vigorous debate about Canadian income taxes was a prominent feature of the 2015 Canadian election. The election of the Liberal government under new Prime Minister Justin Trudeau brought immediate tax changes that will affect the majority of Canadians. The 3 most notable income tax changes, that will affect the majority of taxpayers, are:

  • Reduction of taxes for the middle class
  • Increase of the tax rate from 29% to 33% on income over $200,000
  • Rollback of the tax free savings account (TFSA) limit from $10,000 in 2015 to $5,500 in 2016

Americans in Canada and the new FATCA rules

This change affects all US citizens in Canada, so it’s of widespread effect.  A new Canada- US cross-border tax agreement to exchange financial information is now in place, and a legal challenge to the agreement failed.  The U.S. Foreign Account Tax Compliance Act (FATCA) is designed to target tax non-compliance by U.S. taxpayers with foreign accounts, and this includes US citizens resident in Canada who may have no other connection with the US. FATCA requires U.S. persons including Canadian residents holding reportable accounts at foreign financial institutions, in other words Canadian banks, to report information on an information form attached to their annual tax US return. Failure to meet these reporting requirements  could result in fines of up to $50,000, and the CRA will enforce IRS penalties. The act also requires non-U.S. banks, that is to say Canadian banks, to provide information about U.S. citizens to the IRS.

Top 3 Canadian Income Tax Stories of 2015 as Determined by Canadian Income Tax Lawyer