Here’s a riddle, courtesy of the Tax Court of Canada. How can you not owe any taxes, but still rack up years of interest charges?
The answer to that conundrum is to be found in a recent Tax Court decision on a dispute between the Bank of Nova Scotia and the Canada Revenue Agency.
In 2013 and 2014, the CRA audited one of Scotiabank’s foreign subsidiaries for the 2006, 2007, 2008, 2009 and 2010 fiscal years ending Oct. 31. That audit resulted in the CRA issuing a proposal letter in February, 2015 for the 2006 taxation year, which included a $54.9-million increase to the bank’s income for 2006.
Scotiabank then carried back $54-million in losses from 2008, which was offset against its earlier profit. However, the CRA also assessed arrears interest of $7.9-million, accumulated over the years between 2006 and the date of the reassessment in March, 2015.
The bank appealed that interest bill, arguing that interest should only have accrued until the point that it filed the 2008 tax return that generated the loss it used to offset its debt.
In her judgment, Justice Susan Wong noted that Scotiabank argued “… that Parliament did not intend for a taxpayer to be subject to interest during periods when a loss was available for carryback but the taxpayer does not know to do so until the conclusion of an audit.”
For its part, the CRA said the Income Tax Act is clear. If a carryback loss is used to offset a tax debt, the bill is deemed to have been paid on the latest of four dates, plus 30 days. In Scotiabank’s case, that was March, 2015, when the bank requested that its 2008 losses be carried back. (In fact, that should have been April, 2015, but the CRA neglected to add the 30 days stipulated by legislation.)
However, Scotiabank argued that the circumstances of its situation differed from the statute’s wording, which states that interest is to be calculated from the day a request is made to the CRA for a reassessment. The CRA initiated a reassessment on its own, which then resulted in the bank requesting that its losses be carried back – the order was the reverse of that laid down in the statute.
The CRA called the bank’s position a legal fiction in which taxes were never owed. Instead, the government contended that taxes are owed “until the taxpayer requests an offset by losses carried back,” plus 30 days.
Justice Wong ruled in favour of the CRA, writing that the wording of the statute is unambiguous and that Scotiabank’s differing circumstances “do not lead to different treatment under the interest provisions.” One small victory for Scotiabank: the judge did not add on the extra 30 days of interest that the CRA had omitted.
In an interview, Michael Lubetsky, a partner at Davies Ward Phillips & Vineberg LLP, said the decision underscores the inequities created by Parliament’s 1985 decision to close loopholes around carryback provisions. (Mr. Lubetsky was not involved in the case, but as a tax lawyer has litigated and written on the subject.)
Previous to those 1985 amendments, some companies would intentionally underdeclare income in anticipation of losses emerging in subsequent years that could offset any tax debt that emerged. When they carried back losses, the debt was extinguished, and no interest was paid.
Mr. Lubetsky said that what is in reality an anti-fraud provision should have a limited application – and that companies such as Scotiabank should not be penalized. “My view is that, given that this provision was put into effect for those types of focused circumstances, it should be interpreted accordingly.”
Taxing questions
Responding to last week’s Tax and Spend on new estimates for household carbon costs, one online reader asked whether indirect costs include an increase in the price of all goods, saying that they believe that all costs will eventually flow through to consumers. Is that correct?
The short answer is: No.
Much depends on how companies respond to an increase in carbon pricing (or an increase in costs from regulations, including the output-based pricing system.)
In some cases, companies will find ways to reduce fossil-fuel consumption, either through simple reduced use or energy-efficient capital investments. So, those saved dollars would reduce incremental costs.
Will companies simply pass through the remainder? Export-exposed sectors, in particular, are limited in their ability to pass through costs. In part, that’s why they get more favourable treatment under the output-based pricing system, a type of cap-and-trade regulation.
Even companies that don’t face international competition face limits on their ability to pass through costs, since price hikes will deter some customers and cause them to reduce their consumption or seek out alternatives.
Economists call this the price elasticity of demand. In other words, how quickly does demand fall as prices rise (or conversely, how quickly does demand increase as prices decrease)? If demand for a product is price inelastic, suppliers of that product would be able to pass on costs relatively easily. Gasoline is a good example: there are few options for substitution, at least in the short term. And for many drivers, fuel consumption is largely fixed. A morning commute does not get shorter if fuel prices rise.
But there are price-elastic goods as well, such as soda pop. If prices jump for pop, consumers will buy less, in part because there are many substitutes. Juice, milk, powdered mixes, even tap water: there is a long list of products that consumers can switch to. That will limit the ability of companies to pass on costs.
Lastly, there’s the effect of competitive advantage. Companies that are relatively energy efficient will be better off, and won’t face the same pressures to increase prices. That’s also a constraint on less-efficient companies. If they increase costs, they could lose market share.
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Having your tax-free cake: For a fun tax discussion (there is such a thing), check out this Twitter thread on some of the oddities of GST rules. Artificial wedding cake, for instance, is taxable, since it is not for human consumption. However, if a decorator includes at least one layer of real cake, then the entire confection is tax free – as long as that edible layer weighs at least 230 grams.
Follow me on Twitter, @PatrickBrethour or ask your Taxing Question here.
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