As the tax-filing season approaches, the clock is ticking on two legal challenges to the proposed capital gains tax changes.
Last week two separate applications for judicial review were filed in Federal Court, arguing that the Canada Revenue Agency’s (CRA) administration of the proposed tax changes violates law.
“We have written to the Federal Court asking for an expedited hearing, and, hopefully, we’ll be hearing back from them any day,” said Devin Drover, Atlantic director and general counsel with the Canadian Taxpayers Federation, who is co-counsel for one of the applicants.
“It’ll be up to the court how they triage [the applications] and how quickly they can hear [them],” said Gergely Hegedus, a partner in Dentons’ tax group in Edmonton, noting that the process typically takes months.
“The Federal Court has the ability to offer an expedited hearing,” said Kevyn Nightingale, leader of cross-border tax planning with Levy Salis LLP in Toronto. “That would be justified in this circumstance because timing is really what this is all about.”
Both applications cite Section 53 of the Constitution (among other rules and provisions): “Bills for appropriating any part of the public revenue, or for imposing any tax or impost, shall originate in the House of Commons.”
No authority has been granted to the CRA by way of amendments to the Income Tax Act, Drover said. “That’s what sets this apart from [the CRA’s] normal procedure in implementing changes based on ways and means motions.”
Following the prime minister’s decision to step down and prorogue Parliament until March 24, the Department of Finance confirmed that the CRA would administer the capital gains tax changes as proposed in a notice of ways and means motion tabled in the House of Commons in September. While the CRA’s practice is to administer proposed legislation, these capital gains changes have little chance of passing into law amid dying support and an upcoming election.
“We’re in Never-never land,” Nightingale said. “This is a very strange situation because, unlike most of these announcements [i.e., proposed tax legislation], we can’t take it for granted that [the capital gains proposal] is ultimately going to gain the force of law…. Nobody is sure exactly what to do.”
Bhuvana Rai, a lawyer with Mors & Tribute Tax Law in Toronto, described the applications for judicial review as “necessary” given the uncertainty. “It’s good that we have two of them,” she said.
One applicant, Pelco Holdings Inc., is represented by Thorsteinssons LLP in Vancouver. (The firm didn’t respond to a request for comment.) The CRA’s decision to administer the tax changes puts taxpayers in an unlawful position in which they must certify that their returns are accurate when they aren’t, Pelco’s application suggests. “Completing a return based on CRA instructions that conflict with the law as written could thus expose taxpayers to charges of gross negligence or, worse, criminal prosecution,” it states.
When asked whether that outcome was a possibility for taxpayers, Rai said: “Whenever you’re bringing a legal application, you need to make sure you’re only highlighting those particular problems that apply to your case.”
Still, “I would say that this [i.e., taxpayer certification of a return] is the tip of an iceberg. The issues are even broader,” Rai said. For example, “there’s no authority for a refund mechanism” if taxes are overpaid, she said. “That is material.”
While taxpayers can voluntarily file based on the proposed changes and amend their returns later, “amending has its own problems,” Hegedus said. Taxpayers would incur accounting and administrative costs and a time cost to file amended returns. Plus, their chances of an audit, which can be “costly and stressful,” potentially increase, he said.
Neither applicant has been compelled to pay additional capital gains tax, based on the applications.
The CRA “can provide tax forms that reflect their idea of what the legislation should contain and encourage you to file on that basis,” Nightingale said. “But they can’t force you to do it,” leaving the possibility that the courts won’t rule as the applicants want them to.
Drover said the fact that the taxpayer he represents hasn’t been compelled to pay additional tax doesn’t weaken the application for judicial review. The CRA is “trying to have it both ways,” he said: A taxpayer can file using the 50% capital gains inclusion rate and then potentially face penalties and interest.
As things stand, “The minister of national revenue does have the ability to waive penalties and interests, but that’s a discretionary power,” Hegedus said. “It’s not a given…. The CRA is not going to grant it automatically, so the taxpayers might have to request it.”
Rai highlighted the overall filing uncertainty. “The government normally seeks input and then changes the proposed legislation before enacting it,” Rai said. “In this case, nothing has been enacted, so it’s not even clear what the new proposed legislation would have been.”
“Uncertainty is one of the worst things in tax,” Nightingale said. “It chases capital away.… You get very bad economic effects.”
Regarding the provisional implementation of proposed tax legislation, Hegedus said “the practice makes sense” because it allows the government to project revenues and provides some certainty.
Parliament might want to eventually enact a bill related to provisional implementation, he said. “That’ll give everyone certainty, including government and taxpayers,” Hegedus said.
The joint committee on taxation of the Canadian Bar Association and CPA Canada recommended last week that Finance introduce legislation that would govern the administration of proposed legislation.
The committee also recommended that the capital gains proposals, if enacted, be applicable only to gains realized after a relevant bill is introduced to Parliament. Alternatively, for taxpayers who file based on the 50% inclusion rate, the CRA should waive arrears interest and confirm that penalties wouldn’t be applicable until at least the date that the bill was introduced.
Failed leadership, lost trust
The CRA is caught in a difficult position, Nightingale said, “because there is a notice of ways and means motion that has not been retracted by the government.” To give taxpayers certainty, the government needs to retract the motion, he said.
“Having no legislation for a period of many months after the notice of ways and means motion was presented is grossly negligent,” he added.
“This is a leadership issue,” Drover said. The new ministers of finance and national revenue, and the prime minister could direct the CRA to wait to administer the capital gains changes if or until Parliament passes the proposal. “They failed to do so,” Drover said.
Over his decades-long career, Nightingale said the government has increasingly made tax legislation “by way of announcement.” The capital gains proposal is “an egregious example of that,” he said, and not unique. “Governments are reacting rather than contemplating carefully what is effective,” he said, particularly since the rise of social media.
“One of the things I really like about Canada is that most [taxpayers] don’t cheat,” Nightingale said. “They try and get it right,” which reflects trust in the tax system.
“We toy with that at our peril,” he said.