In the June 11, 2012 issue of Tax Notes International a brief survey of Canadian income tax procedure before the Canada Revenue Agency and courts of applicable jurisdiction was provided by Patrick Lindsay and Salvatore Mirandola of the Borden, Ladner firm in Calgary and Toronto. Since many U.S. tax lawyers, including myself, represent clients north of the border in U.S. tax matters or have been involved in business transactions, including cross border mergers and acquisitions with Canadians, it is helpful to gain a fuller understanding of tax process in Canada. This submission summarizes portions of the recent article.
It should be noted that Jerald David August is not authorized to practice law in Canada and therefore this post is for informational purposes only. A substantial portion of Mr. August’s practice is devoted to international tax matters, both tax planning and tax controversies.
Canada’s Worldwide Tax System
Under authority of the Canadian constitution, the Income Tax Act subjects residents and resident businesses to tax on their worldwide income. As to non-residents, income tax is imposed on Canadian source income (as with Sections 871, 881, 864, 897 under our U.S. income tax system) and from the sale or other disposition of Canadian property, see, e.g., Section 897 (26 U.S.C.). There are also rules, such as are quite common in our country on indirect taxes, withholding obligations, special rates of tax on Canadian sourced passive income including rents, royalties, dividends and interest.
Residents of Canada as well as non-residents deriving income sourced, directly or indirectly from Canada, are required to file an annual income tax return. Canadian Income Tax Act (“ITA”), §150. The deadlines for filing a return are generally as follows: corporations — six months after fiscal year-end; trusts — 90 days after calendar year-end; individuals — April 30; and, when partnership information returns are due, the due date is five months after the fiscal year-end when all partners are corporations, or March 31 in most other cases.
Upon receipt of the return the Canadian Revenue Authority (“CRA”) will send to the taxpayer an initial assessment of tax or a notification that no tax is owing. This notice commences the statute of limitations period (like our Section 6501) within which the tax may be reassess by the CRA with respect to that year. In general, the initial or first assessment notice is issued close in time to the receipt or filing of the return. It is possible, however, that the CRA will delay the first notice to effectively extend the statute of limitations for a reassessment.
As pointed out by Messrs. Lindsay and Mirandola in their article, the general or normal reassessment period for corporations, other than Canadian controlled private corporations and special industry taxpayers, is four years after the initial assessment mailed. The general four year period may be extended by three years in certain instances. A seven year limitation applies with respect to certain multinational entities. Importantly, the limitation period, just like under our tax procedural rules in the United States, can be extended by taxpayer waiver. Waivers can be general or specific as to certain matters. Where a taxpayer delays the issuance of a notice of reassessment through the waiver process, it still may be required to make a down payment of up to one-half of the amount assessed, even if such payment is part of the issue that is in dispute. See, i.e., large corporation’s obligations to pay part of a proposed reassessment that is in dispute.. ITA, §§225.1(7), (8).
As with the U.S. tax law, the ITA provides that no statute of limitations period applies when the taxpayer subject to tax does not file a return. This unfortunate result could occur, for example, where a U.S. company believes that its limited activities in Canada do not constitute the carrying on a trade or business or do not indicate, under the Tax Treaty, that the U.S. company has a fixed base or permanent establishment in Canada. Still, in such instance no return, means no statute of limitations. Note therefore the importance of due diligence and a complete indemnification provision from the target company in negotiating the acquisition of a U.S. based company that has “dabbled” north of the border. In acquiring a Canadian company, the need for some coverage is far more obvious. As with all legal matters that require interpretation of Canadian law, the U.S. legal and/or tax counsel should seek permission from the client to engage the services of a reputable law firm in Canada with lawyers specializing in the area in question such as Canadian income taxation and administration.
As with no return statute of limitations on reassessment, where a tax return is found to have misrepresentation(s) attributable to willfulness, carelessness or neglect the CRA can take the position that there is no period of limitations. Taylor,  CTC 211 (Exch Ct)(burden of proof on the taxpayer.
In no statute of limitation scenarios, the authors note that the current administrative policy of the CRA is to limit reassessment to the latest year under review and the preceding 6 years.
Required Records Doctrine
Taxpayers and their advisors in the U.S. are well familiar with the “required records” doctrine which is codified in (26 U.S.C.) §6001. In like fashion, taxpayers subject to the ITA in Canada are obligated to maintain books and records as well. This not only includes tax return information but state or provincial filings, general ledgers, financial records, and other supporting records which tie into the return. Such required records must be maintained for the life of the company subject to the ITA and two additional years. Records necessary for computing taxes must be retained for a full six years after the year to which they relate. See ITA 230(4), Regulation 5800. Records are to be kept at the person’s place of business or residence in Canada. CRA information circulars 78-10R5 and 05-1R1 provide guidance on the records the CRA expects taxpayers to prepare and maintain.
Like our Internal Revenue Service, the CRA also enjoys broad powers to audit for any purpose related to tax administration and compliance with the IRA. See (26 U.S.C. §§7602, 7609). The stated procedural rules and processes are very similar to ours with respect to audits by the Internal Revenue Service. For audits of multi-national or foreign based companies, the CRA typically issues two formal demands for documents. The first is with respect to Canadian situs records and the second for foreign based records. Deadlines for production are set forth. Certain documents requested by the CRA may be objected to or redeacted based on grounds of privilege, such as the “solicitor-client” privilege. .Descôteaux et al. v. Mierzwinski,  1 S.C.R. 860 is a leading Supreme Court of Canada decision on the solicitor-client privilege Generally, as is true in the U.S., tax return information filed with and inspected by the CRA is to remain confidential subject to applicable exceptions. For the south of the border (United States) application of the attorney-client privilege to bar production of certain documents and communications in federal tax controversies and trials see Jerald David August, “Attorney-Client Privilege and Work-Product Doctrine in Federal Tax Matters”, Business Entities v. 10, no. 4 (July/August 2008)(WG&L)
Initial requests for tax return information and documents by the CRA are informal, such as “IDRs” issued by the Internal Revenue Service. Where the taxpayer does not properly comply the CRA has a choice of remedies apparently. It either can issue a more formal "requirement" to produce documents and information or proceed directly to court for an order directing the taxpayer to comply, which would be tantamount to a summons enforcement proceeding in our country.See ITA §§231.2, 231.7. The CRA’s current practice is to use informal requests when obtaining information directly from taxpayers and to use formal requirements when obtaining taxpayer information from intermediaries, such as accounting firms.
Where the subject of the audit fails to comply timely and fully with the notices for information, the taxpayer can be fined and in rare instances imprisoned. ITA §§ 231.7, 238. The imposition of imprisonment for production failures looks harsh and most likely is akin to our contempt for failure to produce sanctions. In a contempt of audit process case, the defendant-taxpayer will be exonerated if he can prove he acted in good faith and diligently attempted to comply with the documents requested. Dropsy, 2009 FC 820. Failure to produce documents by a taxpayer may prevent such information from later be admitted in a tax proceeding. ITA §231.6(8). GlaxoSmithKline, 4 CTC 2916 (TCC)(2003). Compare with U.S. summons enforcement cases which provide, in general under 26 U.S.C. §7604, that federal district courts have the power to enforce summons, including provision for civil arrest and punishment for contempt. Finally, any person who is duly summoned to appear to testify or produce books and who neglects to take such actions is guilty of a misdemeanor under § 7610.
Before a reassessment is issued, the CRA will issue a notice letter describing the proposed reassessment.The taxpayer is then provided 30 days (or more if allowed) to submit additional information. If the CRA intends to issue a reassessment, the administrative practice is to first issue a proposal letter describing the proposed reassessment. Landsky and Mirandola submit that “A tactical decision to make after receipt of a proposal letter is how much effort should go into collecting additional information and preparing a submission letter. For example, if the reassessment is based on a national policy that the auditor has no authority to overturn, providing additional information may result in costs without any reasonable prospect of avoiding the reassessment. Alternatively, if the proposed reassessment is based on incorrect information the explanation of which is likely to prevent the reassessment, doing the work to make a compelling and complete case against the reassessment may be the most cost-efficient approach.”
When a reassessment is issued it is treated as an obligation of the taxpayer, including additions to tax in the form of interest and penalties. Collection efforts are generally permitted to remain suspended. Again, as mentioned, large corporations are obligated to pay one-half of the amount assessed while the tax dispute with the CRA continues. Even the business lawyer should understand this aspect of Canadian tax procedure in drafting a buyer’s set of required tax covenants and indemnification provisions from the seller company engaged in business operations in Canada. ITA §§225.1(7), (8). There are procedures to pay down the reassessment amount while disputing the matter with the CRA to suspend further assessment of interest.
Upon the issuance of a reassessment, a taxpayer has ninety days from the date of mailing to file a notice of objection. ITA §165(1). An extension for filing may be granted. After filing the objection, a review process commences whereby the Appeals Division of the CRA considers report of the auditor making the proposed reassessment. Requests for administrative review of the “reassessment” can range in detail depending on the nature of the issues at stake. The taxpayer is required to set forth a dollar amount that it seeks relief from as to each issue and overall and the facts and grounds in support thereof. Special procedures and limitations apply to “large corporations”. See, e.g., Potash Corp., 2 CTC 91 (FCA).
Confirmation of Reassessment
The Appeals Division of the CRA Appeals will review the complaint filed and will confirm, modify or remove one or more issues contained in the request for reassessment. This can be a time consuming process. When Appeals agrees with the taxpayer, a new reassessment will be issued to restore the taxpayer to its position as initially filed. When Appeals disagrees the reassessment will either be confirmed or a new reassessment will be issued that reflects the settlement reached on some issues and confirms the CRA’s position on the issues that remain in dispute.
Taxpayers, as an alternative to filing for an administrative review, may file a notice of appeal to the Canadian Tax Court after the objection to the CRA’s reassessment is made. This may be true in certain instances due to the delay of the CRA to respond to an objection to a reassessment.
The petition to the Canadian Tax Court generally requires the same type of recitation of facts and grounds for relief as are required under the Tax Court Rules. TCRs 23 and 24. The CRA files a response and is permitted to raise alternative arguments after the limitation period has expired to support its position, taxpayers gain some certainty knowing that after the limitation period has expired the amount of tax owing for the year cannot be increased. ITA §152(5).
Appeal to the CanadianTax Court
Where the Appeals Division upholds, in whole or in part, the reassessment after the Appeals decision is made, the taxpayer is required to appeal to the Canadian Tax Court within 90 days. Canadian TCC 55. A reply is issued by the Minister of National Revenue (MNR) represented by the Department of Justice Canada within sixty days. As with US Tax Court Rule 37, the government admits, denies or claims lack of knowledge with respect to the facts and grounds for relief asserted by the taxpayer.
Once the reply is filed, the taxpayer may file an answer to add additional facts or grounds for relief with a thirty day period. TCC Rules 45 and 50. Other forms of motions, e.g., particular, strike, etc., are provided under the rules. After the period for filing the reply, and additional motions has ended, the appeal and reply can be amended only by consent of the Tax Court. TCC Rule 54.
The Canadian Tax Court rules provide litigation timelines, list of production of documents, exchange of documents, etc. Compare US Tax Court Rules 50-58. Motions can be brought at any time during the litigation process. Motions are generally concluded before the hearing date. Common motions include, compelling production of additional information or documents, compelling answers to questions refused on discovery, and challenging the content of pleadings.
After pre-trial practice is concluded and a status report and list of witnesses and experts are provide, the case, if not settled, will move towards trial. At the hearing, the judge has broad discretion regarding the admission of evidence.67 Generally, counsel for the taxpayer calls evidence first, often by submitting a statement of agreed facts, calling fact witnesses and expert witnesses when needed, and submitting any relevant portions from the examination for discovery transcript. The Department of Justice then follows the same process, following which each side presents oral argument.
[The Tax Court of Canada is the youngest superior court in Canada. The Court’s jurisdiction includes the hearing of appeals from assessments under the Income Tax Act, the Excise Tax Act (Goods and Services Tax “GST”), the Employment Insurance Act and the Canada Pension Plan, among others. The Tax Court of Canada was established in 1983 pursuant to the Tax Court of Canada Act. The Court is independent of the Canada Revenue Agency and all other departments of the Government of Canada].
Federal Court of Appeal
Upon the filing of a judgment by the Tax Court, either side can file an appeal to the Federal Court of Appeal (FCA) within 30 days. As to hearing legal issues, the standard is that of “correctness” for which the FCA has wide discretion. As to factual matters the standard for reversing a finding by the trial court is that of “palpable and overriding error”. Housen v. Nikolaisen, 2002 SCC 33. The Federal Court of Appeal is a court established by Parliament in accordance with provision of section 101 of the Constitution Act, 1867.
The Supreme Court of Canada
A further appeal from an adverse FCA decision to the Supreme Court of Canada (SCC) is only available when the SCC grants leave to appeal, which is uncommon and is limited to situations when the SCC is convinced that the issue in question is one of national importance. An application for leave to the SCC must be filed within sixty days of the FCA decision.