OECD Base Erosion and Profit-Shifting – First Recommendations

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OECD Base Erosion and Profit-Shifting – First Recommendations

The OECD, on 16 September 2014, released its first set of recommendations for combating tax avoidance by Multi-National Enterprises (MNEs). These recommendations require a coordinated approach by countries. These recommendations were introduced through a speech by Secretary-General Angel Guirria. The claim made is that these recommendations will put an end to base erosion and profit shifting that erode the integrity of national tax systems.

The OECD Committee on Fiscal Affairs brought together 44 countries – consisting of all OECD members, G20 countries, and Accession Countries – so as to gain consensus on the recommendations.

The first recommendations cover seven (7) elements of the BEPS Action Plan:

ITA-Annotated will deal with these first recommendations separately and in detail. The recommendations do address some issues of global tax justice, but avoid (by nature of the very structure of the BEPS project) many others. The biggest question, left perhaps for another day, the question of the equitable distribution of revenues and income as among nations: The question of source vs residence. The BEPS project was only meant to address the exploitation, though ‘abusive tax planning’ and ‘aggressive tax avoidance’ of existing gaps and loopholes in the current international tax regime only. For an analysis of the use of the terminology and unexamined assumptions and ideology involved, and the need to examine these, see this paper by Prof Allison Christians.

This post will provide an overview of the first seven recommendations. Later posts will examine each in detail, taking both an international and a Canadian perspective. The BEPS project requires nations to buy in and implement the recommendations in domestic law (domestic coordination) and changes to existing treaties through a multi-lateral treaty.

The explanatory statement issued by the OECD sets out the recommendations in broad strokes. The aim of the OECD project is to create consensus-based international tax rules that protect the tax bases of, mainly, developed and capital exporting countries. The new rules aim to avoid double taxation of international income without allowing for artificial shifting of profits to low/no-tax countries or double non-taxation.

The first seven recommendations aim to:

  1. Neutralise hybrid mismatch arrangements – prevent multiple deductions for a single expense, deduction in one country without inclusion in another, and generation of multiple foreign tax credits for one amount of tax paid.
  2. Address treaty shopping and treaty abuse – seen as undermining tax sovereignty by avoiding the bilateral nature of tax treaties, and addressed by introducing anti-treaty abuse provisions in treaties
  3. Reduce transfer-pricing abuses using intangibles – rules that address the separation of the location of returns from the location where the intangible is used to create profits and create value.
  4. Require country-by-country reporting of economic activity, profit attribution, and taxes of MNEs – to improve transparency, improve transfer pricing documentation, and increase the quality of information available to tax authorities by clearly indicating where profits, sales, employees, and assets are located and where the taxes are paid and accrued.

The overall aim of the project is to tax profits where the economic activity giving rise to the profits occur and where value is actually created.

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Medical Marihuana – Excise Tax Obligations of Sellers

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Medical Marihuana – Excise Tax Obligations of Sellers

 Hedges v The Queen, 2014 TCC 270

Justice Campbell Miller, in his usual style, provided a detailed and well-reasoned decision, somewhat clarifying this complex and problematic area of law.

At issue was whether dried marihuana grown and sold by the Appellant was zero-rated or not.  Justice Miller held that dried marihuana is, perplexing to the common man, being a “Drug” under the federal Food and Drug Act, is not a “Drug” for purposes of the Excise Tax Act because of the interplay of the Narcotics Control Regulations or the Controlled Drug Substances Act.  In short, dried marihuana is not zero-rated.

In coming to this conclusion the court differentiated the decision of the Ontario Superior Court of Justice in R. v. Mernagh2011 ONSC 2121, and relied on the definition of “prescription” as determined in R v Falconi, 1976 31 C.C.C. (2d) (144) (Ont Cnt Crt)., and Pagnotta v R, (2001) 4 C.T.C. 2613  – being that a prescription requires a communication by a doctor to someone to prepare or dispense a substance in stated amounts; a definition not met by the medical declaration for medical marihuana.

It is best to quote the conclusions:

[97]        As is often the case, where statutes or regulations that arise subsequent to other pertinent legislation are to be interpreted in the context of that earlier legislation, there can be an awkwardness to the interpretation. That is what I am faced with. While I have found the term “drug” in the opening part of Schedule VI‑I‑2(d) of the Act can only be interpreted to include dried marihuana, this conclusion, given the ongoing evolution of marihuana-related legislation, renders the exclusionary clause (ie. beginning with “other than” in Schedule VI‑I‑2(d) of the Act) somewhat oblique in its application to dried marihuana.

[98]        Appellant’s counsel have raised strong and thought provoking arguments for an interpretation resulting in dried marihuana being zero-rated but, with respect, they have lost sight of the forest for the trees. This was most apparent to me in their argument that the exclusion in Schedule VI‑I‑2(d) of the Act was an exclusion of over-the-counter drugs. Po-Chi, I find, is more akin to an over‑the‑counter drug than a drug acquired by prescription: one has little or no Government control versus significant Government control.

[99]        The legislation has twisted itself out of shape by requiring the sale to a consumer pursuant to the Controlled Drugs and Substances Act regulations, being the MMARs, without prescription or exemption. It contemplates only lawfully managed drugs. And if a lawfully managed drug can be acquired without prescription (which I have determined dried marihuana can be by ATP) then it is not zero‑rated. And if it is not zero-rated, then dried marihuana that is not subject to the Controlled Drugs and Substances Act regulations cannot be zero-rated. It would be a nonsensical result otherwise. As I have intimated earlier in these Reasons, this area of legislation needs work. If the Government intends that all sales of dried marihuana are to be zero-rated, say so clearly. If the Government intends that all sales of dried marihuana are to be subject to GST, say so clearly. If the Government intends to have dried marihuana as a prescribed drug and only dried marihuana obtained by a prescription is to be zero-rated, say so clearly.

[100]   There is understandable confusion in the industry on this point. My conclusion is clear – dried marihuana sold by Mr. Hedges is not zero-rated. I cannot say, however, with a great deal of enthusiasm, that I have clarified the legislation itself: there remain gaps and inconsistencies. Regrettably, that is the nature of this legislative beast.

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New Housing Rebate – Factors as to Intention

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New Housing Rebate – Factors as to Intention of using property as primary residence at time of signing the agreement

Berkovich v The Queen, 2014 TCC 268

The only issue before the court was whether the Appellants were entitled to claim the HST/GST New Housing Rebate under the Excise Tax Act. This turned on the question of whether, at the time of signing the agreement of purchase and sale, they intended to purchase the unit as their primary residence.

The court reviewed the fact and identified the following relevant factors when assessing whether the requirements under paragraph 254(2)(b) were met (referring to Yang v Canada, 2009 TCC 636):

  • the intention of the party as to the use of the housing unit;
  • the length of stay at the new unit;
  • the address used for correspondence;
  • when the party moved personally compared to when their furnishings and personal property moved;
  • reasons for any delay in moving;
  • details of insurance coverage; and
  • what happened to the former residence.

The objective factors are meant to support or refuse the stated subjective intention of the Appellant (Kukreja v Canada, 2014 TCC 56).

In this particular case the court also considered the following factors are relevant objective factors:

  • The Appellants health issues;
  • The Hydro usage of the property;
  • Changes of Address for mailings;
  • Lack contents insurance when insurance at one unit; and
  • Parking spaces sufficient for vehicles owned.

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Disability Tax Credit – Ensuring that the Certificate is Correct

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Disability Tax Credit – Ensuring that the Certificate is Correct

McDermid v The Queen, 2014 TCC 264

The Taxpayer claimed the Disability Tax Credit pursuant to section 118.3 for two of the taxpayer’s children.  The certification requirement was met, but the court stated that it must still ensure that the certificates are correct.  In other words, the court must ensure that the statutory requirements are met:

[7]             The relevant statutory requirements are:

a)     the impairment is severe,

b)    the impairment is prolonged, in the sense of lasting for at least 12 months,

c)     the person is unable, all or substantially all of the time, to perform the mental functions necessary for everyday life, or can only do so by taking an inordinate amount of time, and

d)    a medical doctor or psychologist has certified in prescribed form that the above conditions are satisfied.

These provisions have to be interpreted liberally, humanely, and compassionately: Radage v The Queen, 96 DTC 1615.  The impairment, to qualify for the credit, must be of such severity that the person is rendered incapable of performing such mental tasks that will enable the person to function independently and with reasonable competency in everyday life (para 9): Radage v The Queen, 96 DTC 1615 .  The court stated at paragraph 15:

[15]        The legislation does not require a severe impairment with respect to all daily activities. It merely requires that mental functions be severely impaired all or substantially all of the time. For example, a child may qualify for the DTC with a severe impairment with respect to remembering, and yet be able to eat and dress herself. To qualify, it is not necessary that the child be unable to perform any activity on her own

The Court commented (as the court has on many other occasions) that the check-the-box form used by the CRA is capable of representing a misleading picture of the disability (para 14).  The court held that the Minister’s reliance on the form was misplaced (para 16).

The evidence convinced the Court only that one of the children met all the statutory conditions.  The son’s disability, mainly due to the auditory working memory problems, required significant support. The daughter, however, was held not to be so impaired in her daily activities to qualify for the credit.  Justice Woods was clear to say that this does not mean that the daughter will not qualify in the future, when she is older and her daily activities become more complex (para 24).

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Large Corporation Rules for Tax Appeals – Motion to Strike

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Large Corporation Rules for Tax Appeals – Motion to Strike

Devon Canada Corporation v The Queen, 2014 TCC 255

The Income Tax Act, subsection 169(2.1) limits the issues and relief that large corporations may appeal to only those issues and related relief in respect of which they complied with subsection 165(1.11) in their Notices of Appeal.

On this motion to strike, the only issue was whether the portions sought to be struck were issues and relief in regards to which the large corporation complied with subsection 165(1.11).

ANALYSIS

The TCC recognizes that subsection 165(1.11) has not yet been fully analyzed by the courts, but identified the following items from the cases at paragraph 11:

[11]        The courts have not yet had the opportunity to fully consider the parameters of subsections 165(1.11) and 169(2.1) but there are themes that have emerged from the cases that have been decided:

(a)       a taxpayer is not required to describe each issue exactly but is required to describe it reasonably (Potash Corporation of Saskatchewan Inc. v. The Queen, 2003 FCA 471);

(b)      the determination of what degree of specificity is required for an issue to have been described reasonably is to be made on a case by case basis (Potash);

(c)       a taxpayer may add new facts or reasons on appeal but not new issues (British Columbia Transit v. The Queen, 2006 TCC 437);

(d)      if the proposed additional argument would result in the large corporation seeking greater relief than was previously sought, the courts are more likely to consider the argument to be a new issue rather than a reason (Potash; Telus Communications (Edmonton) Inc. v. The Queen, 2005 FCA 159);

(e)       if the proposed additional argument would result in the large corporation seeking the same relief that was previously sought, the courts are more likely to consider the argument to be the same issue (British Columbia Transit; Canadian Imperial Bank of Commerce v. The Queen, 2013 TCC 170); and

(f)        if the proposed additional argument would result in the large corporation seeking completely different relief than was previously sought, the courts are more likely to consider the argument to be a new issue rather than a reason (Bakorp Management Ltd. v. The Queen, 2014 FCA 104).

Before determining whether the impugned arguments are new issues or new reasons, the court must first determine what issues were set out by the taxpayer in its Notice of Appeal. If the alternative arguments are merely alternative reasons in support of the issues raised, there is no problem.  But where the alternative arguments are new issues, they must be struck.

The TCC held that the sole issue set out by the taxpayer in its Notice of Objection was the deductibility of surrender payments. Although the Notice of Objection sets out one reason why this deduction should be permitted, the taxpayer is no preluded from raising other reasons in the Notice of Appeal (para 15).  It does not matter that the alternative reason is a new reason that is a result of a later development of the case law.

So long as the alternative arguments were alternative reasons for allowing the deduction of the surrender payments they were not struck.  However, there will be a new issue of the taxpayer seeks to deduct additional amounts, even if those amounts fall within the same category of deductions: Potash.

The taxpayer argued that the Crown’s acceptance of its Supplemental Memo has the effect of altering its Notice of Objection.  The Court rejected this argument and stated that the ITA does not provide a mechanism for a large corporation to amend its Notice of Objection.

Paragraph 165(1.11)(b) requires that the taxpayer specify the relief sought in respect of each issue, and not in respect of each reason (para 21). If a certain amount of relief is specified in the Notice of Objection, a less favourable amount of relief is automatically included: Potash.

Although subsections 165(1.14) and 169(2.1)(b) together allow a large corporation to appeal to the TCC in respect of new issues despite the fact that those issues were not described in its Notice of Objection.  The Court, however, identified a gap in the ITA being where the Minister confirms  reassessment on a basis that differs from the basis upon which a large corporation objected.  There is no ITA provision allowing a large corporation to appeal on the basis of the new issues.

The court held that this was not the case for granting relief by closing the perceived gap because the Minister had not abandoned the original basis of its reassessment – rather only added additional explanations to deal with supplemental arguments raised by the taxpayer’s supplemental memo.

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Income Tax (Federal & Provincial) – HST/GST – International Tax