The Federal Court of Appeal (FCA), in Marc St-Pierre v. The Queen, allowed the taxpayer’s appeal of a notice of reassessment that purported to include a shareholder loan in the taxpayer’s income. The reassessment itself was triggered by an error in a capital dividend account (CDA). The taxpayer’s approach to remedying the error is of interest to middle market businesses. This case highlights that how taxpayers interact with and respond to the Canada Revenue Agency (CRA) may not only affect tax outcomes, but also the ease and timeliness of resolving issues.
The dispute arose from an error in computing a corporation’s capital dividend account for its 2008 taxation year, the year in which the corporation mistakenly declared dividends in excess of its CDA balance. On February 1, 2008, the corporation disposed of eligible capital property, resulting in a capital gain of $900,000. Half of the gain was not taxable. Under the CDA calculation provisions in the Income Tax Act (Act), the non-taxable portion of the gain should be added to the corporate’s CDA account but not until 2009. Prior to the sale, the corporation had an opening CDA balance of $146,881. However, the CDA for the 2008 taxation year was incorrectly recognized as $596,881 (rather than $146,881) by Taxprep 2008 software because it calculated that the $450,000 non-taxable portion of the gain was to be recognized in CDA in 2008, rather than 2009.
On February 2, 2008, a resolution was prepared authorizing the corporation to declare capital dividends of $596,881 to the taxpayer. For the reasons described out above, the amount of the capital dividend was $450,000 higher than the corporation’s CDA balance for the 2008 taxation year. There was no dispute that the corporation would eventually be permitted to declare and pay a capital dividend of $596,881. However, the corporation declared the dividend earlier than the time prescribed by the Act because the CDA account balance was only $146,881 in the 2008 taxation year.
To resolve this issue, the taxpayer filed a motion in the Superior Court of Quebec to quash the CDA resolution (i.e., to annul the CDA resolution). Of relevance to this article is the fact that the CRA had recommended that the taxpayer seek rectification of the CDA resolution rather than pursuing a motion to quash. In April, 2013, pending the hearing of the motion to quash, the CRA reassessed the taxpayer on the basis that the amounts declared in excess of the corporation’s CDA account were taxable to the taxpayer under subsection 15(2) of the Act and the taxpayer would also be taxable on a deemed interest benefit under section 80.4 of the Act.
The CRA’s position was that, in anticipation of the Quebec Superior Court’s decision retroactively quashing the capital dividend resolution, the taxpayer was unjustly enriched and the amounts were therefore considered a debt incurred by the shareholder to the corporation under subsection 15(2), with interest at the rate prescribed by section 80.4.
A motion to quash vs. rectification
In 2011, the CRA sent a letter to the corporation informing it of the error in February 2008 CDA resolution. The CRA stated that the capital dividend amounts declared in excess of the CDA account would be taxable under Part III of the Act rather than tax-free as a capital dividend.
Following discussions, the CRA agreed not to assess the corporation under Part III of the Act, provided the taxpayer requests rectification of the February 2, 2008 resolution. Rectification is a remedy to correct an error in a written document to reflect the true and primary intentions of the parties. If the taxpayer and the corporation had applied for rectification to correct the amount of the CDA resolution, the escalation of the dispute to the FCA might have been avoided because the CRA had committed to not assessing the taxpayer provided the taxpayer follow the CRA’s instructions to file a motion to rectify the February 2, 2008 resolution.
Instead, in January 2013, the taxpayer filed a motion for a declaratory judgement with the Superior Court of Quebec to have the resolution quashed retroactively and deemed never to have existed. As compared to a rectification, a motion to quash is a request to a court to render null or invalid a written document containing an error that does not reflect the original intention of the parties. The Quebec Superior Court allowed the motion. As a result, the full amount of the capital dividend declared was deemed to be null and the CDA resolution was deemed never to have existed. The taxpayer repaid to the corporation the amounts he had received with interest at the prescribed rate.
There was no clear explanation from the taxpayer as to why he decided to proceed with a motion to quash instead of a rectification as recommended by the CRA. The Tax Court of Canada (TCC) suggested that the taxpayer’s decision could have been influenced by the Superior Court of Quebec’s judgment in 2009 in Félix & Norton International Inc. c. Canada. In that case, a motion to quash the company’s resolution declaring capital dividends was allowed because its accountant had provided inaccurate figures and management had thus authorized a resolution that did not reflect its intention. A possible benefit of filing a motion to quash might be that the corporation could issue a new resolution and file a new subsection 83(2) capital dividend election with the CRA because the original resolution is deemed to have never existed. The taxpayer in St-Pierre did, in fact, file a new resolution and election in October 2015.
At the trial level, the TCC accepted the CRA’s argument and concluded the taxpayer had received amounts to which he was not entitled. Therefore, the taxpayer was unjustly enriched and subsection 15(2) of the Act applied. The taxpayer appealed the TCC’s decision to the FCA.
The FCA concluded that the CRA did not have the factual basis to assess the taxpayer under subsection 15(2) and section 80.4 of the Act before the Superior Court quashed the CDA resolution. The taxpayer did not have a restitution obligation until January 6, 2014, the date of the Superior Court’s decision annulling the resolution. Because restitution was not possible before that date, there was no debt before January 6, 2014 and, therefore, no unjust enrichment prior to that date. The FCA also found that even if there were unjust enrichment starting on January 6, 2014, it would have been remedied when the amount was paid back in October 2015. Therefore, the FCA allowed the taxpayer’s appeal and set aside the notice of reassessment.
Weighing the alternatives for relief sought
Although the taxpayer may have felt that judicial precedent favoured a motion to quash in similar circumstances, and although a motion to quash provides taxpayers with a ‘blank slate’ to produce new written documents (rather than correct existing ones), taxpayers should weigh the pros and cons of alternative remedies, where several are available. Opting to quash versus rectify may affect the outcome, costs and timeliness of the disputes process.
In this case, the CRA had shown its willingness not to reassess and impose penalties on the corporation under Part III of the Act, provided the taxpayer and the corporation file an application for rectification. When the taxpayer decided instead to pursue a motion to quash and annul the resolution, the CRA reassessed the amount on another basis. If the taxpayer had accepted CRA’s recommendation and filed an application for rectification, it can be argued that they would have avoided landing in the ultimate tax situation (i.e. no excessive capital dividend declared) whilst incurring the time and cost related to the new reassessment.