Principal Issues: Is the CRA willing to accept a designation under paragraph 55(5)(f) late filed in light of the decisions in Nassau Walnut Investments Inc. v. The Queen, 97 DTC 5051, and Administration Gilles Leclair Inc. v. The Queen, 97 DTC 880?
Position: CRA's long standing practice is to apply subsection 55(2) only to the excess of the taxable dividend over the safe income on hand, when issuing an assessment based on subsection 55(2). In a situation where a corporation would refuse to deduct its safe income on hand from the taxable dividend subject to subsection 55(2), for example, in order to convert the safe income on hand into a capital gain as part of a dividend stripping scheme the application of the GAAR could be raised.
Reasons: The FCA decision in Nassau Walnut Investments Inc.
FEDERAL TAX ROUNDTABLE 7 OCTOBER 2011
2011 APFF CONFERENCE
Question 10
Late filed paragraph 55(5)(f) designation
In Administration Gilles Leclair Inc. v. The Queen [1997] 3 CTC 3053, (TCC), 97 DTC 880, and Nassau Walnut Investments Inc. v. The Queen (CA), [1997] 2 FC 279, 97 DTC 5051 ("Nassau Walnut"), the judges allowed the taxpayers to file a late election under paragraph 55(5)(f), but thereby giving rise to a penalty.
However, there is no provision in the Act which provides for such a late-filing of a designation. Neither subsection 220(3.2) nor section 600 of the ITR refer to paragraph 55(5)(f). Consequently, on a strictly legislative basis, it is not possible to make a late election.
Question to the CRA
Would the CRA be willing to accept a late filed designation under paragraph 55(5)(f) in light of the jurisprudence?
CRA Response
You stated in your question that nothing in the Act allows a late election under paragraph 55(5)(f) and consequently, on a strictly legislative basis (i.e. a literal interpretation of the Act), it is not possible to make a late election.
That position is exactly what the Minister of Revenue advocated in Nassau Walnut and which was rejected by the Federal Court of Appeal ("FCA") for inter alia the following reasons:
- First, the FCA pointed out that courts have long adopted a contextual and purposive approach to statutory interpretation rather than a literal approach (at page 5057).
- Furthermore, having considered the purpose of subsection 55(2) and paragraph 55(5)(f), the FCA stated that paragraph 55(5)(f) does not provide for an election. According to the FCA, in some respects, the designation requirement of paragraph 55(5)(f) of the Act is no different, for example, than the deduction provided for under subsection 112(1) in respect of taxable dividends. The only substantive difference between the two sections of the Act is that no computation is required under subsection 112(1), whereas the deduction in paragraph 55(5)(f) involves computing safe income before the deduction can be made (page 5058).
- The FCA also concluded that Nassau Walnut was required to make a designation at the time it filed its income tax return for the relevant year (page 5052).
Given the FCA’s judgment in Nassau Walnut, the CRA's long-standing administrative practice is to apply subsection 55(2) only in respect of the excess of the taxable dividend over the safe income on hand when issuing an assessment.
The CRA's administrative practice is consistent with the purpose of paragraph 55(5)(f), as described by the FCA in Nassau Walnut (at page 5059): "... [T]o prevent the conversion by subsection 55(2) of an entire dividend into taxable capital gain where a portion of that dividend might be attributable to safe income… .”
Furthermore, the courts have repeatedly emphasized that the safe income on hand of a corporation should not be subject to double taxation. In this regard and as an example, we refer you to paragraph 32 of The Queen v. Kruco Inc., 2003 FCA 284, 2003 DTC 5506, paragraph 4 of Lamont Management Ltd. v. The Queen (CA), [2000] 3 FC 508, 2000 DTC 6256, and paragraph 13 of The Queen v. Brelco Drilling Ltd. (CA), [1999] 4 FC 35, 99 DTC 5253.
Moreover, in a situation where a corporation declines to deduct its safe income on hand from the taxable dividend subject to subsection 55(2), for example, in order to convert the safe income on hand into a capital gain as part of a surplus stripping scheme, we are of the view that subsection 245(2) could be invoked.
In particular, we are of the view that, in a particular situation, there is abusive tax avoidance where subsection 55(2) is used to strip the surplus of a corporation. In that regard, we believe that the comments of the Supreme Court of Canada in The Queen v. Trustco Mortgage Canada, 2005 DTC 5547, is relevant:
"45. This analysis will lead to a finding of abusive tax avoidance when a taxpayer relies on specific provisions of the Income Tax Act in order to achieve an outcome that those provisions seek to prevent. As well, abusive tax avoidance will occur when a transaction defeats the underlying rationale of the provisions that are relied upon. …”
Marc LeBlond
(613) 957-2108
2011-041209