Quoted in the Law Times on changes to the Income Tax Act

Tax changes could have costly consequences

Proposed changes to private incorporation tax rules could have costly consequences for corporate clients, say lawyers who have reviewed potential shifts to the Income Tax Act. The federal Liberal government has been at the centre of ongoing controversy over the proposed changes, which were announced this summer and could go into effect later this fall.

BY Dale Smith 25 Sep 2017

Proposed changes to private incorporation tax rules could have costly consequences for corporate clients, say lawyers who have reviewed potential shifts to the Income Tax Act.

The federal Liberal government has been at the centre of ongoing controversy over the proposed changes, which were announced this summer and could go into effect later this fall.

The changes could cause double taxation for clients with private corporations or family trusts in some circumstances, lawyers say. The changes could also end up taxing a holding company’s assets at a rate of 70 to 90 per cent, they say.

Marion Howard, a tax lawyer in solo practice in Campbellville, Ont., says new anti-avoidance rules being added to s. 246.1 of the Income Tax Act will have an impact on the capital dividend accounts of private corporations by subjecting them to new taxation.

Howard says some corporate lawyers may not be aware of the intricacies of how the change will impact a shareholder’s income tax.

“They don’t realize that they have to potentially contact all of their clients and tell them that they need to rework their shareholder agreements and the ownership of their life insurance,” says Howard.

Section 246.1 is headlined in the proposal as intending to address “non-arm’s length dividend stripping — individual” and is intended to be an anti-avoidance measure to prevent the distribution of a corporate surplus to an individual shareholder on a tax-free basis, a practice known as “surplus stripping.”

“Myself and other tax lawyers are afraid that the way that 246.1 is drafted, whether it was intended or not, we can’t pay a capital dividend out of the capital dividend account,” she says.

Howard says this is urgent because the new rules are effective as of July 18 of this year, when the proposed changes were announced.

In particular, Howard is concerned about how these changes will mean a corporation can no longer pay out a tax-free dividend related to life insurance paid into a capital dividend account when a shareholder dies, at least not until the company is wound-up.

“All those shareholder agreements out there are all set up to accommodate this corporate-owned life insurance,” says Howard. Therefore, it may be more advantageous to change the policies to individual holders instead, which wouldn’t be subject to additional taxation.

When asked about tax lawyers’ concerns about these potential consequences, Finance Minister Bill Morneau told Law Times that, currently, a period of consultation about the changes is ongoing.

“To the extent that people have concerns around language, around how the plans will work, we’re going to listen because we want to get it right,” says Morneau.

“But, again, our objective is to make sure our system is fair.”

Brandon Siegal, principal of Siegal Tax Law in Toronto, says that the government’s attempts to stop tax deferral will mean that there is less incentive to invest in the economy and that the resulting taxation on private corporation dividends would be double taxation, with rates up to 73 per cent.

“It creates an environment where you are explicitly worse off making money through the corporation than you were beforehand,” says Siegal.

Robert Kepes, partner with Morris Kepes Winters LLP in Toronto, says the new language with s. 246.1 mirrors a section, 247.1, that was taken out of the act in the mid-1980s with the introduction of the General Anti-Avoidance Rule.

GAAR states that where transactions are only being attempted to reduce, avoid or defer taxes owing, they may be invalidated by the Canada Revenue Agency.

“I think one of the reasons they’re bringing this in is because there have been some court cases that have said there isn’t a general policy in the Income Tax Act against dividend stripping,” says Kepes. “I think they’re introducing 246.1 so that the government can point to it and say that there is a policy.”

The Canadian Bar Association says proposed tax changes deserve a longer and more thoughtful consultation period than the 75 days the government allotted. The association had come under fire from some members after it opposed the changes as part of the Coalition for Small Business Tax Fairness.

“We have facilitated a process through which our members can express their views,” says spokeswoman Katya Hodge.

Editor's note: Change made Sept. 28, 2018 at 4:47 p.m. to clarify point made by Marion Howard in 10th paragraph.

Quoted in the Law Times on changes to Lawyer taxation

Concerns voiced over tax change

BY Alex Robinson 26 Jun 2017

Lawyers are decrying a proposed change to the Income Tax Act, which they say could greatly affect lawyers’ cash flow.

Critiques have continued to pile up after the release of the 2017 budget, where the federal government has proposed to eliminate billed-basis accounting, which allows lawyers and some other professionals to exclude the value of work in progress from their income. 

This lets lawyers defer paying taxes on work until it is billed.  

Lawyers say the change could be burdensome for lawyers who might not have the cash flow to pay tax on work for which they have not billed their clients.

“It’s pretty devastating,” says Leigh Taylor, a tax lawyer with Leigh Somerville Taylor PC in Toronto. She says the change doesn’t mean more tax for lawyers, but it does mean they must pay tax earlier. 

Taylor says the change also means lawyers will have to take a meaningful look at their revenue recognition policies and will likely have to bill clients more frequently. 

“If you had [work in progress] at the end of a calendar year that [wasn’t] billed until the next, tax is now going to be payable in a year, even though you might not have the cash flow to pay the tax, which is unfortunate,” she says.

News of the change was contained in the federal budget in March. 

It stated that billed-basis accounting would be eliminated, which lawyers say will mean abolishing s. 34(a) of the Income Tax Act that allowed for the deferral. 

The section was first enacted because it is difficult to value work in progress, as lawyers do not necessarily know what they are going to bill until they have enough information to render a bill, Taylor says. 

The change will impact most lawyers next year, as it will take effect in the tax year that starts after the budget. 

But concerns have continued to mount, with the Canadian Bar Association recently sending a submission to the federal government asking for further legislative guidance about the change, a de minimis test and longer transition period. 

Tax lawyer Brandon Siegal says going forward lawyers are going to need to make sure to have their accounting systems set up to value work in progress to ensure it is reported.

He says this change will mean lawyers will end up having to pay 13 months’ worth of income tax in one shot. 

Lawyers are going to need to plan for it and create a work-in-progress fund.

“There was this hopeful benefit of always kicking the can down the road by one year. That’s gone.”

Siegal says that as lawyers and professional corporations are required to have a calendar year end under the Income Tax Act, the first year will be the one that starts on Jan. 1, 2018. 

Those that incorporated after the budget was released on March 22, 2017, however, will be caught this year.

David Stevens, a partner with Gowling WLG, says the change will be particularly problematic for practice areas such as personal injury but also technically difficult for a significant portion of the profession as well.

“It’s significant and somewhat troubling,” he says. 

Siegal says it is not clear how work in progress will be assessed for contingency work, as it may or may not be billable in the end. 

The Canada Revenue Agency, however, issued guidance at the end of April, saying no amount is receivable by the lawyer until the right to collect the amount is established.

Lawyers say the rationale for the elimination of billed-basis accounting is likely that work in progress should not be deducted while associated expenses are deducted, and that professionals should be given a deferral that is not available to other taxpayers. 

The federal government has said there will be a transitional period to phase in the elimination of billed-basis accounting. 

For the first taxation year that starts after the budget was released, 50 per cent of “the lesser of the cost and the fair market value of work in progress will be taken into account for the purposes of determining the value of inventory held by the business,” and for each year after, the full amount will be taken into account, according to a document on the budget’s tax measures. 

In its submission, the CBA said the proposed transition period is not adequate for long­ established practices that have work-in-progress balances, which have built up over years. 

The CBA has asked that the government consider a transition of five to seven years. 

A spokesman for the Ministry of Finance declined to comment on the issue. 

Law Times Op-Ed against Tax Shaming

Speaker's Corner: Stop being ashamed of tax planning

09 Jan 2017

Over the last few years, there has been an uncomfortable rise in the trend I call tax shaming. That is the outrage on social media and from politicians attempting to cast any attempt to manage or reduce taxes as immoral.

Recent examples include Apple’s CEO being called before the United States Congress to defend its tax strategy, and the suggestion in the recent American election by the media that the application of prior-year losses is a loophole.

Other examples include the so-called Panama Papers, in which leaked law firm files led to a public outcry about possible unreported offshore income, and the perceived unfairness of secret deals being granted by the Canada Revenue Agency under the voluntary disclosure program, as well as when the shareholders of Silver Wheaton last year launched a class action lawsuit against the company alleging fraudulent tax filings because of a disputed CRA reassessment.

The winds of public opinion toward taxes are changing and the Canadian government has been quick to take advantage, zealously issuing press releases to provide real-time updates to promote the aggressive audit of those named in the Panama Papers.

In litigation, allegations of sham — suggesting that taxpayers entered into improper transactions with an intent to deceive the government — are increasingly being added to government pleadings with little consideration as to the impact of such accusations on a taxpayer’s reputation.

Even if successfully defended in court, the tarnish on a company’s image from the assertion of sham will remain. Similarly, the language used by the government when publicizing the 2016 budget is concerning.
The government emphasized in the budget that it would provide the CRA with an additional $444.4 million over five years to “address tax evasion and aggressive avoidance.”

In discussing the expected returns from its increased investment, the government has been quick to conflate the concepts of legal tax avoidance and illegal tax evasion as being equally deplorable. 

This is in direct contrast to our laws, which have long allowed taxpayers to organize their affairs to reduce taxation.

The principle is named after the Duke of Westminster, who famously won a 1936 House of Lords case.
The duke had restructured his gardener’s wages as a covenant to pay in order to make them tax deductible and the House of Lords endorsed his ingenuity. 

In Canada, the Duke of Westminster principle is alive and well.

The Income Tax Act prohibits through the General Anti-Avoidance Rule only the most abusive tax avoidance — which is admittingly difficult to define and even harder to prove. Otherwise, the Supreme Court has continually affirmed the Duke principle, including in the recent decision, Jean Coutu Group (PJC) Inc. v. Canada.

Some taxpayers are so afraid of being tax shamed for non-abusive planning that they are accepting either legally indefensible reassessments or voluntarily paying additional taxes.

Starbucks famously paid 20 million pounds in U.K. taxes as a result of negative publicity. I have personally seen taxpayers walk away from, or settle at a discount, otherwise strong cases out of fear of the reputational damage that might arise from publicly engaging in a tax dispute.

There is no basis in Canadian law for voluntary payments of additional taxes. Taxes are calculated under the Income Tax Act with only limited taxpayer discretion mainly relating to the timing of deductions such as depreciation on capital assets or the application of prior losses.

In fact, taxpayers may be denied the assistance from the competent authorities under Canada’s various tax treaties for help to reduce double taxation that results from a taxpayer-initiated voluntary adjustment, as opposed to a post-audit government-initiated adjustment.

This leads to an interesting question for lawyers. In the event that a government, or public opinion, pressures or “tax mails” a client into voluntarily paying more taxes, what is our role as advocates? Should we sit back and let clients willingly pay additional taxes to avoid potential reputational risks or should we advocate for them to respect the rule of law and defend their rights to manage their tax affairs?

Perhaps the right approach is to fight by educating the public.

The next time an accusation is made that an infamous president-elect improperly used a loophole by carrying forward losses, an explanation should be given about how unfair it is to tax to businesses based upon arbitrary calendar years.

Startup costs can be substantial and markets are volatile, leading to possible losses between January and December of any given year.

It has been a long-standing principal of fairness in almost every tax system to allow such losses to be applied against other years’ profits.

That is not a loophole.

And when it is suggested that the CRA’s voluntary disclosure program unfairly lets people get off easy through secret deals, it should be explained that the only deal being offered is the waiver of penalties that are applicable only after the non-reporter is caught. Every dollar of newly reported tax must still be paid in full along with partial interest.

These are taxes that likely would either never have been collected or would have been collected only after an expensive and time-consuming audit.

The voluntary disclosure program has been an unmitigated success.

Despite operating on a shoestring budget, the program captured in fiscal 2014-2015 more than $1.3 billion of previously unreported income.

One thing is clear: In this day and age, while the duke may not be dead, he needs a better publicist.

Brandon Siegal is the founder of Siegal Tax Law, a boutique tax dispute resolution firm, and has experience with McCarthy Tétrault LLP and the Department of Justice. He can be reached at brandon@siegallaw.com.