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Tuesday, October 4, 2011

Prescribed Information To Support ITCs

An ITC claim must be supported by information prescribed in subsection 164(4) of the Excise Tax Act and in the Input Tax Credit Information (GST/HST) Regulations. The TCC in Les Pro-Poseurs Inc. (2011 TCC 113) recently considered whether invoices provided by the taxpayer to support its ITCs met the information requirements. The decision reconfirms that the ETA's and the regulations' information requirements are mandatory, not directory, and that compliance is compulsory if one wishes to claim ITCs.
In Les Pro-Poseurs, the appellant was a construction contractor that subcontracted out its work overflow. For the relevant period, the CRA rejected the appellant's claims for ITCs related to supplies of property and services purportedly acquired from a number of "dubious" suppliers (the subcontractors). The appellant appealed to the TCC.
The minister submitted that the invoices provided by the appellant to support its ITCs failed to meet the information requirements because they did not contain sufficient information to allow identification of the alleged supplies and determination of the ITC amount. The minister found that the subcontractors did not have staff or equipment to make the alleged supplies, some of them were untraceable, and some were in default to Revenu Québec with respect to several tax statutes. On the basis of those findings, the minister further submitted that the invoices were false because the subcontractors could not have provided the supplies to the appellant. Furthermore, because the subcontractors cashed most of their cheques from the appellant at cheque-cashing businesses, which charged an "astronomical commission," the minister suggested that the invoices in question were invoices "of convenience," having been prepared merely in order to allow the appellant to inappropriately claim ITCs.
At the TCC, the appellant submitted that the minister erred in concluding that the invoices were fictitious on the basis of his profile of the subcontractors and that, on the evidence, the appellant had established a prima facie case that the subcontractors actually provided it with the supplies. Although some of the prescribed information did not appear on the invoices, the appellant said that those strict requirements should not be imposed because most of the construction workers involved did not have "a gift for writing" and that the supporting documents met the industry standard.
The main issue before the TCC was whether the appellant was entitled to the ITCs claimed. The court first considered whether the appellant actually acquired the supplies from the subcontractors; it drew a negative inference from the fact that the appellant did not call witnesses (such as the subcontractors' officers and employees) who could have testified in support of the appellant's position. In determining whether the appellant's evidence made out a prima facie case that demolished the minister's assumptions in making the assessment, the TCC concluded that the testimony of the appellant's witnesses was either deficient or not credible in establishing that the subcontractors actually made the supplies to the appellant.
The TCC then considered whether the invoices provided by the subcontractors met the information requirements. The court concurred with its earlier views in Key Property Management Corporation (2004 TCC 210) and Davis (2004 TCC 662) to the effect that the legislative and regulatory requirements were mandatory and must be strictly enforced: the whole purpose of the provisions was (as stated in Key Property) "to protect the consolidated revenue fund against both fraudulent and innocent incursions." The court said that the invoices provided by the subcontractors did not meet the information requirements because they did not contain the information necessary to allow the minister to identify the work carried out by the subcontractors. Because the evidence weighed against the appellant, the TCC concluded that the appellant could not claim the ITCs related to those invoices issued by the subcontractors.
The courts have set a very high bar for anyone attempting to get around the mandatory information requirements for ITC claiMs. The TCC in Pro-Poseurs stressed that "[i]t is for the Court and not the industry to determine what the legislator means by 'description of each supply sufficient to identify it.'" The decision is a red flag for all businesses: to perfect an ITC claim, the best prescription is to ensure that each invoice issued by a supplier contains all the prescribed information.
Robert G. Kreklewetz and Jenny Siu
Millar Kreklewetz LLP, Toronto

US Tax Collection in Canada

How far the US tax authorities' reach extends into Canada in respect of US tax liability and penalty collection depends on the status of the debtor and the nature of the debt or penalty. The following discussion relates to the collection of taxes and associated interest, foreign bank account report (FBAR) penalties, fraud penalties, penalties for failure to pay, and accuracy-related penalties, all of which obligations are imposed under the Internal Revenue Code, except for FBAR penalties, which are imposed by the Bank Secrecy Act.
The general common-law position in respect of collection of foreign tax debts is set out in United States of America v. Harden ([1963] SCR 366). The US government attempted to collect a tax debt by registering the debt as a civil debt in a Canadian court. The court concluded that by attempting to collect taxes in this manner, the United States was attempting to enforce its revenue laws in Canada, a violation of the longstanding rule that a sovereign state will not collect taxes for the benefit of a foreign state. Quoting Peter Buchanan Ld. & Machaig v. McVey, the SCC adopted the reasoning of the High Court of Ireland that "in no circumstances will the courts directly or indirectly enforce the revenue laws of another country." The court said that "[n]o court ought to undertake an inquiry which it cannot prosecute without determining whether those laws are consonant with its own notions of what is proper." There is no distinction between the underlying claim and the collection of that claim.
That common-law position of non-enforcement is altered by article XXVI A of the Canada-US treaty, which establishes authority for assistance in the collection of tax debts. This assistance is provided in respect of "revenue claims": "all categories of taxes collected" "together with interest, costs, additions to such taxes and civil penalties" and "contributions to social security and employment insurance premiums levied by or on behalf of" the US government, which includes taxes and penalties imposed under the Code. The CRA treats US taxes and penalties that fall within this description in the same way that it treats domestic debts and uses its collection tools to recover the money. Thus, US tax owing, and interest and penalties ancillary thereto, is collectible under those treaty provisions. However, the treaty contains an important exception: assistance is not provided if the individual is a Canadian citizen.
In contrast, FBAR penalties are assessed for failure to report, and they are not connected to an underlying tax debt or to any penalty under the Code. The specific enumeration of social security and employment insurance contributions in the definition of revenue claim in article XXVI A(9) makes it clear that the treaty drafters turned their minds to other types of government debts that do not fit within the general description of "all categories of taxes collected." Thus, FBAR penalties are not collectible under article XXVI A because they are not income or capital taxes or taxes imposed under the Code or related penalties. There is still potential for the competent authorities to agree to extend the meaning of "tax" to include FBAR penalties in accordance with article XXVI A(11).
The United States may pursue recourse in Canadian courts regarding the collection of FBAR penalties. With respect to a foreign penal debt, the rule is clear: Canadian courts will not enforce it (Pro Swing Inc. v. Elta Golf Inc., 2006 SCC 52). The underpinning rationale is that foreign law conflicts with and encroaches on domestic law and thus the sovereignty of the domestic state. "Penal law" is defined in United States of America v. Ivey (1995 CanLII 7241 (ONSC), aff'd. 1996 CanLII 991 (ONCA)) as "all suits in favour of the State for the recovery of pecuniary penalties for any violation of statutes for the protection of its revenue or other municipal laws, and . . . all judgments for such penalties." FBAR penalties should not be enforced because they appear prima facie to fall within that description: they serve to punish a US citizen or green-card holder for his or her failure to report to the US government. Furthermore, FBAR penalties are not compensatory and do not affect the disgorgement of profits. (See Ivey; United States Securities and Exchange Commission v. Cosby, 2000 BCSC 338; and United States of America ( SEC ) v. Shull, 1999 CanLII 6625 (BCSC).
Harden makes it clear that taxes cannot be collected pursuant to registration of a civil judgment in a reciprocal jurisdiction. Although FBAR penalties are not taxes, it is highly likely that they are penal and thus are not enforceable in Canada. However, some uncertainty exists, and it may be possible to collect FBAR penalties in Canada on the principle of comity, discussed in Morguard Investments Ltd. v. De Savoye ([1990] 3 SCR 1077): a foreign judgment for a debt may be enforced in Canada if the party brings a separate action in a Canadian court.
In summary, a Canadian citizen need have little concern about the collection of US tax, interest, and ancillary penalties. However, a US taxpayer who is a Canadian resident and not a Canadian citizen and who owes US tax, interest, and penalties may face collection thereof by the CRA pursuant to treaty article XXVI A. It is extremely unlikely that Canadian citizens or residents will have to face collection of FBAR penalties, except in the very unlikely event that those penalties may be characterized as registrable civil judgments.
Erin L. Frew and S. Natasha Reid
Thorsteinssons LLP, Vancouver

Obligations of US Green-Card Holders and Citizens

For at least the last few decades, Canadians emigrating to the United States have had to consider the fairly onerous obligations that attach to the holder of a green card or of US citizenship. A Canadian who moved to the United States for business reasons may have been advised to get a work visa instead of applying for permanent residence; a US parent living in Canada may have been advised not to rush US citizenship for a child born a Canadian citizen, and, if the child was deemed to be a US citizen, to have that child renounce citizenship or expatriate at age 18. More recently, US citizens resident in Canada may have been advised to relinquish their US citizenship if their net worth and US tax were below the thresholds for the expatriation rules. Obtaining a green card or US citizenship is attractive because it allows the holder to live and work in the United States, but each brings a lifetime of weighty US tax responsibilities.
  • A US citizen must always file a US form 1040 tax return regardless of where he resides and, subject to some minor relief (the foreign earned income exemption of about US$90,000), must pay US tax on worldwide income computed under US rules. Effectively, these rules mean that a US taxpayer living in Canada pays tax at the higher of the two rates--US and Canadian--on all income and cannot benefit from tax incentives in the other country. For example, a US citizen resident in Canada cannot benefit on his or her US tax return from the deduction for an RRSP contribution or the 100 percent deduction for Canadian exploration expenses, because the US tax is effectively increased to the extent that foreign tax credits for Canadian tax have been reduced. Similarly, although Canada has a principal-residence exemption, any gain exceeding US$250,000 on the sale of a Canadian house is taxable in the United States to a person obliged to file a US return for worldwide income.
  • US gift tax may restrict estate freezing, asset protection, and gifting to spouses and children. The traditional Canadian corporate estate freeze attracts US gift tax; elementary asset protection such as having the family home in the name of the non-US citizen is difficult to accomplish, given the gift tax parameters; and the permitted annual gift is US$13,000 to each child and US$134,000 to a non-US-citizen spouse. Gifts of US$100,000 or more received from non-residents must be reported by the donee.
    The US estate tax and gift tax of up to 35 percent for estates over US$5 million may impair or preclude the transfer of wealth to the next generation.
  • Annual reporting requirements apply to settlors and beneficiaries of foreign trusts. Non-reporting may trigger penalties of 35 percent of the value of property transferred to a trust, 35 percent of distributions therefrom, and 5 percent a month for gifts from non-US persons. Reporting is also required of foreign grantor trusts.
  • Controlled foreign corporation rules require that tax be paid on subpart F (passive) income regardless of whether that income is distributed. These rules may apply to a US-citizen Canadian resident who forms a Canadian holdco to own investments.
  • Passive foreign investment company (PFIC) rules require the taxation of undistributed passive income and gains in foreign (non-US) companies not controlled by US shareholders. To be a PFIC, a foreign corporation must have passive income of at least 75 percent of its gross income, or 50 percent or more of its assets must generate passive income. Recent amendments require annual reporting by PFICs regardless of whether distributions are made. A US$10,000 non-filing penalty is imposed.
  • A foreign bank account report (FBAR) must be filed on pain of onerous penalties for non-compliance: if non-filing is wilful, 50 percent of the account balance computed annually may be forfeited, and criminal sanctions may also be imposed. Multiple years of non-reporting may result in penalties that exceed the cash in the account. Financial interests in or signing authority over bank accounts, securities accounts, and other financial accounts in foreign countries must be reported annually.
  • Disclosure requirements are part of the tax return for specified foreign financial assets with an aggregate value over US$50,000 and require reporting--separate from the FBAR rules--of depository accounts, financial accounts, stocks and securities issued by a non-US person, and an interest in a foreign entity. The minimum non-compliance penalty is US$10,000; a 40 percent additional penalty is imposed for undisclosed or undervalued foreign financial assets.
  • Expatriation rules (departure tax) apply if the US citizen or green-card holder decides to renounce his or her green card or US citizenship. Some US reporting is required for 10 years after expatriation if the person's assets exceed US$2 million and annual taxes exceed a threshold. If an individual makes a gift in the 10 years following his or her expatriation, the recipient may be subject to gift or estate tax.
  • Effective in 2014, a US citizen who wishes to open a foreign bank account or an investment account will experience increased difficulties as a result of FATCA (the Foreign Account Tax Compliance Act). FATCA can result in a 30 percent withholding on payments made to a foreign financial institution that does not enter into an IRS disclosure agreement that requires it to identify US accounts and report them to the IRS annually. The bank must inquire about the account holder's citizenship and place of birth. In consequence, many foreign banks are refusing to deal with US citizens.
  • Temporary but punitive voluntary disclosure rules apply and include a fixed penalty, taxes, and interest on previously undisclosed amounts.
Jack Bernstein
Aird & Berlis LLP, Toronto