Interview with Joel Scheuerman, Partner, Leader of Tax Litigation & Controversy for Western Canada, Deloitte Legal Canada LLP;
and Ingrid Reynolds, Partner, Tax and Legal, Deloitte Canada
1. What is the most significant change to your region/jurisdiction’s tax legislation or regulations in the past 12 months?
Joel Scheuerman
Of particular relevance to tax controversy matters, on 4 November 2022, the Minister of Finance introduced legislation (Bill C-32) amending Section 231.1 of the Income Tax Act (Canada) (the Act).
Because Canada’s taxation system is founded on the principle of taxpayer self-assessment, Parliament has conferred wide-ranging audit powers on the Canada Revenue Agency (the CRA) to facilitate the administration and enforcement of the Act.
Bill C-32 would, among other things, significantly expand those powers wielded by the CRA in conducting taxpayer audits.
Ingrid Reynolds
There is draft legislation which is being treated as virtually enacted by practitioners, to eliminate the tax benefits of certain hybrid mismatch arrangements. This was released by the Department of Finance Canada (henceforth referred to as Finance) on 29 April 2022.
This draft tax legislation addresses the tax benefits associated with hybrid cross-border arrangements that otherwise result in discrepancies in the tax treatment of entities or financial instruments across the jurisdictions. This also includes new rules to restrict the tax deduction of certain dividends received from foreign affiliates.
Finance intends for the proposed hybrid mismatch arrangement rules to apply to payments arising on or after 1 July 2022, including payments under arrangements entered before that date.
2. What has been the most significant impact of that change?
Joel Scheuerman
Recent jurisprudence has held that, although they are broad, the audit powers granted to the CRA by current Section 231.1 of the Act are not without limits. In particular, the courts held that the CRA may not i) compel taxpayers to disclose the particulars of uncertain tax positions contained in their tax accrual working papers; or ii) compel taxpayers (or their employees) to provide oral answers to questions or attend interviews.
Bill C-32 seeks to overturn these decisions and would empower the CRA to require taxpayers or other persons to give all reasonable assistance and answer all proper questions either orally (whether in person or virtually) or in writing, in any form specified by the CRA, and as requested by the CRA.
The meaning of “all proper questions” is also expanded by Bill C-32 to include any questions “relating to the administration and enforcement of the Act.” In contrast, current Section 231.1 only requires taxpayers to answer questions relating to their books and records.
Ingrid Reynolds
The draft legislation results in significant changes and uncertainty for multinationals, in particular Canadian-based multinationals.
The hybrid mismatch draft legislation includes an anti-avoidance rule that may apply to transactions with similar characteristics of a hybrid mismatch arrangement in substance, even though one or more of the defined technical requirements of the hybrid mismatch rules are not met, making these rules difficult to navigate.
3. How do you anticipate that change impacting your work and the market moving forwards?
Joel Scheuerman
Bill C-32 will result in increased costs and a greater compliance burden for taxpayers. For example, since oral interviews are inherently unpredictable and subject to interpretation, taxpayers may find themselves in need of greater assistance from advisers experienced in cross-examination at the early stages of CRA audits.
Ingrid Reynolds
This broad drafting of the legislation, which potentially catches non-abusive situations, coupled with Finance’s announcement to proceed with consultation on potential revisions to Canada’s existing transfer pricing and other anti-avoidance rules (as confirmed in the 2022 Federal Budget), has the potential of significantly increasing the complexity of cross-border tax arrangements involving Canada, further increasing the compliance burden as well as the potential for a tax dispute.
4. How has this changed the way you offer tax advice?
Joel Scheuerman
Bill C-32 may increase the need for taxpayers to seek recourse from the courts to make certain that appropriate limits are placed on the CRA’s expanded audit powers.
The interpretation of what constitutes a “proper question” or “reasonable assistance” under Bill C-32 may inevitably require the courts’ guidance and oversight.
Ingrid Reynolds
We are advising clients with complex tax arrangements to expect the Canadian tax authorities to challenge these transactions and to retain audit-ready material immediately following the transaction, including source data, step plans, and all related correspondence.
It is difficult to gather this detail at the time of an audit, and key personnel are often no longer with the organization. Additionally, where an audit is anticipated, efforts can be made during or immediately following the transaction to clearly document the business purpose and anticipated tax consequences of all steps. We are assisting clients with compiling these “audit-ready” files.
5. What potential other legislative/regulatory changes are on the horizon that you think will have a big impact on your region/jurisdiction?
Joel Scheuerman
Bill C-32 sets out additional amendments to the Act that would have the effect of increasing taxpayers’ disclosure obligations. Briefly, these amendments would require taxpayers to proactively disclose a range of transactions to the CRA. They would also require large corporate taxpayers to disclose details of any uncertain tax positions reflected in their audited financial statements.
Bill C-32 would impose significant financial penalties and other negative consequences if these disclosure obligations are not met.
Ingrid Reynolds
Beyond Pillar 2, the Excessive Interest and Financing Expenses Limitation (EIFEL) rules will have the most impact in Canada. Finance released draft legislation on 3 November 2022, related to the EIFEL earnings stripping rules. Generally, the rules are intended to limit deductible net interest and financing expenses to 30% of a corporation’s adjusted taxable income (ATI) – which is essentially a version of earnings before interest, taxes, depreciation and amortization (EBITDA), as determined using Canadian tax principles. The rules are effective for taxation years commencing on or after 1 October 2023.
6. What are the potential outcomes that might occur if those changes are implemented?
Joel Scheuerman
These amendments would further increase the compliance burden on taxpayers, and important elements of the Bill C-32 may give rise to court challenges, resulting in increased uncertainty for both taxpayers and the CRA.
Ingrid Reynolds
The EIFEL rules are expected to alter capital investment decisions and may move capital out of Canada.
While the measures have been described as aimed principally at multinational organizations and cross-border investments, the EIFEL rules may also apply to domestic taxpayers with no foreign operations in respect of third-party debt owed to non-resident persons.
Based upon the draft legislation, this may lead to adverse tax consequences for certain taxpayers as well as act as a disincentive for large organizations with whom the government is looking to be leaders in certain key initiatives. For example, organizations that are committed to achieving net-zero emissions by 2050 and require funding to do so.
7. Do you think that change will have a positive effect on both your practice and the wider regional/jurisdictional market?
Joel Scheuerman
Bill C-32 is expected to result in a net increase in compliance costs and uncertainty for taxpayers, until such time as the courts provide greater clarity regarding the broad language contained in Bill C-32.
Ingrid Reynolds
Although the EIFEL rules are broadly in line with the approach set out by the Organisation for Economic Cooperation and Development (OECD) in its report on Action 4 of its Base Erosion and Profit Shifting (BEPS) initiative, the draft legislation adds yet another layer of complexity to Canada’s tax regime.
8. Are there any regulatory/legislative changes you believe should be implemented in your region/jurisdiction?
Joel Scheuerman
Canada’s self-assessment system is premised on the assumption that taxpayers are best positioned to identify, compute, and report the amounts of tax imposed on them by the Act. This assumption persists through to the courts, where the rules of litigation in tax matters require taxpayers to rebut any facts assumed to be true by the CRA in reassessing them.
In light of the expanded audit powers conferred on the CRA by Bill C-32, coupled with language that is vague or open to interpretation, this long-standing assumption should be revisited.
It may be time to revisit the current tax litigation model that imposes the obligation on taxpayers to, in the words of the Supreme Court, “demolish” the CRA’s assumptions of fact. Such reform would, however, require broad consultation.
Ingrid Reynolds
Although there is inherent asymmetry in a self-reporting tax system where taxpayers (theoretically) know all the issues and hold all the evidence, it is more than compensated for by the Minister of National Revenue’s broad audit and investigation powers and the power to assess on the basis of factual assumptions and impose the burden of proof on taxpayers. Codification of further symmetry or proportionality in certain respects would also be helpful. For example, taxpayers are required to comply with strict deadlines for many filings, with any combination of penalties, interest or even loss of rights as a consequence for missing these deadlines, however, the Minister only has to assess “with all due dispatch” under certain parts of the Act.
9. How do you believe those changes would help improve the tax landscape in your market?
Joel Scheuerman
These changes would buttress the principles of fairness, transparency, and predictability upon which Canada’s tax assessment system is based.
Ingrid Reynolds
Increasing the symmetry between the taxpayer and the Minister, in certain respects, should add clarity to the tax system and make the tax process more efficient and fairer in Canada.
10. How are issues surrounding the taxation of the digital economy affecting your work?
Joel Scheuerman
[Intentionally left blank]
Ingrid Reynolds
It is yet to be seen. The federal government is planning on proceeding with the implementation of a Digital Services Tax (DST) if an international agreement is not approved by 1 January 2024. If an agreement is not in effect, the DST would be payable as of 2024 with respect to revenues earned as of 1 January 2022.
We anticipate the DST affecting our client’s internal processes as well as financial recording and reporting, and impacts on our assistance with tax automation are already being observed.
11. How would you describe the tax authorities’ approach in your region/jurisdiction?
Joel Scheuerman
When delays and roadblocks arise in resolving audit disputes at the administrative level within the CRA, we have observed a preference for taxpayers to proceed directly to the Tax Court of Canada, as this can lead to a more efficient resolution forum.
This is likely due to the fact that the overwhelming majority of litigated tax disputes result in a settlement prior to a court hearing. Our experience shows that complex tax disputes are often best resolved pragmatically, out of court.
Ingrid Reynolds
The CRA staffing has increased exponentially in departments such as International Tax and Aggressive Tax Avoidance, and the sophistication of the CRA has increased in certain audit respects, such as transfer pricing. With administrative changes, however, auditors and team leaders are often required to refer matters to headquarters on many items. This has, on occasion, led to delays in the resolution of audit matters. In practice, taxpayers must then object to or litigate the disputed matter where the Headquarters determines that the CRA disagrees with the taxpayer’s tax treatment.
Despite this administrative hurdle, the Tax Court’s statistics are quite encouraging. It should be very reassuring to taxpayers across the country that the dispute resolution system, particularly its judicial arm, is very effective at bringing taxpayers and the CRA together in finding common ground.
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