Article by Kim G. C Moody, Tim Clarke and Lisa Handfield1
I. INTRODUCTION
Comparing prices is a hobby of many shoppers and this may be equally true when it comes to paying taxes as many individuals, corporations and trusts alike "shop" jurisdictions for the lowest rate. Despite equalization payments amongst the provinces, the provinces do not appear to be able to provide equivalent services to their residents at similar levels of taxation. While the varying costs of providing provincial services may be due to the presence or absence of other revenues, such as royalties, or the number and dispersion of their residents, the bottom line remains – there is significant variation amongst provincial taxation rates.
Due to advancements in technology, society today is undergoing a future shock2 – a structural change which can sometimes be overwhelming. With this change comes almost seamless mobility of capital which may allow entities to shift wealth to lower tax jurisdictions. Arguably, advances in technology increase mobility of labour as well; for instance, thousands of workers from across the country commute to Alberta's oil sands for work. Given this increased mobility of capital and labour, rate "shopping" amongst provinces becomes easier.
This paper will consider a number of inter-provincial issues, beginning with a review of the legislative framework under which provincial income for individuals, trusts and corporations are levied as well as the tests for residency. A variety of inter-provincial plans are then discussed as well as recent case law. The paper concludes with some comments on the general anti-avoidance rule (the "GAAR").
II. LIABILITY FOR TAXATION
Individuals, trusts and corporations are liable for tax in Canada on their worldwide income pursuant to subsection 2(1) of the Income Tax Act (Canada)3 (the "Act") if they are resident in Canada during the period. The occurrence of residence in Canada provides the basis for the jurisdiction to tax and thus creates the liability for taxation of a person.4 In addition to being liable for taxes under the Act, individuals, trusts and corporations are liable for taxation on a provincial basis as levied by the various provincial tax acts. Provincial taxation is generally levied on a similar basis, that of residency.
Non-residents of Canada are taxable on income from an office or employment pursuant to section 115 of the Act and Regulation5 2602 will impute this income to the province(s) in which the duties thereof were performed. Similarly, a non-resident corporation will be taxable on its Canadian source income under section 115 of the Act. Non-resident corporations may also be subject to the "branch tax" pursuant to Part XIV of the Act, which generally will be applied to Canadian-source business income and related taxable capital gains. Non-residents are also taxable if they carry on business in Canada or dispose of taxable Canadian property. Withholding tax is applicable to interest, rents, royalties, dividends and management fees paid or credited to non-resident persons. Similarly, as a general principle, business income is taxed in the province where it is derived.
III. CONSTITUTIONAL FRAMEWORK FOR PROVINCIAL INCOME TAX
1. The Federal and Provincial Taxing Power
Under subsection 91(3) of the Constitution Act, 18676 (the "Constitution"), Parliament has unlimited power to impose any mode or system of taxation. Unlike the provinces, there is no qualitative or territorial limit to Parliament's authority to impose taxes. While the provinces are limited, Parliament may impose any form of direct or indirect taxation inside or outside Canada.7
The province's powers of taxation are limited to raising revenue for provincial purposes by means of direct taxation within the province under subsection 92(2) of the Constitution. The words "raising of a revenue for provincial purposes" have been given little significance by the courts, specifically the phrase puts no functional limit on the purposes for which a province may raise taxes.8 In other words, the provinces have the power to tax individuals based on residence, domicile, employment, or carrying on business in the province as long as the connection to the province is substantial.9
2. Direct Taxation
The requirements that taxes be "direct" and "within the Province" are of legal ambit. The courts10 have adopted John Stuart Mill's distinction between direct and indirect taxation:
A direct tax is one which is demanded from the very person who it is intended or desired should pay it. Indirect taxes are those which are demanded from one person in the expectation and intention that he shall indemnify himself at the expense of another.11
While this distinction appears clear, it is not an easy concept to apply in the context of modern taxation statutes. Indeed, although a tax imposed upon the net income of a corporation carrying on business will usually be passed on to its customers, such a tax has been ruled to be direct.12 An individual cannot pass on an income tax levied on employment income therefore it is a direct tax.13 The distinction between a direct and indirect tax lies in the "general tendencies of the tax and the common understandings of man as to those tendencies,"14 meaning if the general tendency is for the tax to be passed to another person, the tax is indirect, if not, it is direct.
Most modes of taxation have now been classified as direct or indirect but there remains differences in the proper approach to classification. It has been held by Justice La Forest of the Supreme Court of Canada that when a tax falls within an established "direct" category, then the Mill's "passing-on" test should not be applied, but instead the tax or any variant is presumed to be direct.15 However, Justice Iacobucci of the Supreme Court of Canada disagreed maintaining that the Mill's test should be applied to each new tax whether it is a variant of a predecessor tax or not.
3. "Within the Province"
Subsection 92(2) of the Constitution restricts the provinces to levying direct taxation "within the province". The Supreme Court of Canada held in Rex v. Cotton16 that for a provincial tax to be valid the "subject" of taxation must be within the province. Succeeding cases held that for the purposes of the provincial taxing power, the subject matter of a tax pertains to "persons, property, transactions or benefits" within the province.17 Specifically, the Supreme Court of Canada in Dunne c. Quebec (Sous-ministre du Revenu)18 discusses what connection to the province is required for the province to be able to levy provincial income tax. The Court noted that subsection 92(2) of the Constitution is construed broadly and with flexibility to include the "power to tax residents of the province...[and also to] tax property, businesses and transactions within the province".19
4. The "Extra-Provincial Facts" Doctrine
The wording of subsection 92(2) of the Constitution contemplates the imposition of a tax on provincial residents as they are undeniably "within the province". Further, the Privy Council ruled in Bank of Toronto v. Lambe20 ("Lambe") that Quebec could tax "any person found within the province", therefore the tax in question was properly levied because the taxpayer carried on business in the province even though it was not resident there.
This case is notable because the Court held that the tax could be computed with reference to paid up capital outside Quebec thus establishing the right of a province to impose a tax on a person found within the province but computed with reference to "extra-provincial facts".21 In other words, the province may impose an income tax on its residents even on income earned outside the province22 where the quantum of such tax is measured by extra-provincial attributes.23
In Manitoba v. Air Canada24 ("Air Canada") the Supreme Court of Canada ruled that a retail sales tax on liquor sales on through-flights over Manitoba and on short term layovers on the way to destinations outside the province was ultra vires because the aircraft did not have a "situs" within the province. There must be a substantial or at least more than a nominal presence in the province to provide a basis for imposing a tax. In contrast, in Air Canada v. Minister of Revenue et al.25 the Ontario Court of Appeal ruled that Ontario could tax jet fuel that was purchased and primarily consumed outside the province by Air Canada and Canadian Airlines merely because it was physically transferred to the aircraft in Ontario. The court ruled that the refueling transactions were "within the province" and therefore the tax was within the provincial power.
It is difficult to determine where to draw the line between the concept of "nominal presence" in the province for flyovers and layovers, and the more substantial concept of transactional nexus which applied to fueling transactions. Given that provinces may impose a tax on residents based on extra-provincial facts and on non-residents undertaking transactions within the province, there appears to be no constitutional impediment to two or more provinces taxing the same income, hence the need for an interprovincial income allocation formula.
5. The "Agreeing Province" System of Provincial Income Taxation
Before the provincial "Tax Rental Agreements"26 were struck in 1941, the broadly framed provincial taxing power resulted in a maze of overlapping federal, provincial, and municipal income taxes.
In 1962 some provinces entered into tax collection agreements with the federal government which were designed to, among other things lessen the possibility of double provincial taxation arising from the "extra-provincial facts" doctrine. Under the original agreements the federal government undertook to administer and collect provincial tax without charge if the provinces agreed to:
- impose a single rate of tax calculated as a percentage of basic federal tax;
- compute taxable income in accordance with the federal Act;
- impose personal income tax only on those individuals who are resident in the province on December 31; and
- compute taxable income earned in a province by a corporation in accordance with the interprovincial allocation formula contained in the Act and Regulations (also to avoid double taxation).
Over time, the "tax on tax" formula was relaxed to allow the provinces flexibility to impose tax at varying rates on taxable income. If a province agreed to compute taxable income under the Act and allocate that taxable income among provinces under the formula in the Regulations, it was free to impose any tax rate it wished.
6. Federal-Provincial Fiscal Arrangements Act
The federal and provincial income tax arrangements are governed by the Federal-Provincial Fiscal Arrangements Act27 (the "FPFAA"). Specifically, the federal government levies tax on behalf of the provinces through a series of tax collection agreements ("TCA")28 which are provided for under the FPFAA. The federal government has TCA with all of the provinces, except Quebec,29 for the collection of personal income taxes. For ease of administration, the TCA requires that provincial income taxes to be levied on the same basis as federal income taxes meaning that the provinces are required to use the federal definition of "taxable income". However, the provincial income tax may be calculated using a tax on income method which calculates provincial income tax payable by individuals as a percentage of their taxable income. This method of calculating provincial taxes payable allows the provinces to set their own tax rates and determine which non-refundable tax credits they will offer.
With respect to the taxation of individuals, the federal government currently gives an abatement of 13.5 percentage points of its personal income tax pursuant to the FPFAA to allow room for the provinces to impose taxation.30 The federal government also cedes 1.0 percentage point of its corporate income tax under the FPFAA. Technically speaking, a tax abatement is deemed to be a payment of tax made on December 31 as per Regulation 6401.
The legality of the TCA were challenged in Gendis Inc. v. Canada31 where the corporation, Gendis, undertook a corporate reorganization that allowed the corporate group to utilize the differences between section 85 of the Act and a parallel rollover provision in the Quebec Taxation Act32 (the "QTA") to avoid provincial tax liability in respect of a sale of property which resulted in a capital gain (the "Quebec Shuffle"). Subsequent to the Quebec Shuffle, Gendis was assessed under the Manitoba provincial tax legislation that was passed retroactively to target such transactions. Gendis argued, not that the legislation was invalid, but that the application of the legislation to the transaction in question was invalid on the basis that the specific provision in the Manitoba legislation33 could not be enforced as it was not a tax collected on the federal income basis as stipulated by the TCA. The Manitoba Court of Appeal held that the Canada Revenue Agency (the "CRA") had the ability to collect and transmit taxes and such ability was not strictly limited to the terms of the TCA as there was an ongoing agency relationship of consensual administrative delegation, thus the Minister of National Revenue (the "Minister") could validly levy an assessment under the Manitoba legislation in this circumstance against the corporation.
Quebec has never been an agreeing province and consequently it computes personal and corporate taxable income and tax under its own legislation and administers and collects tax without the federal government's assistance. Several of the more elaborate interprovincial tax plans were designed to exploit the lack of integration between the provincial tax regimes for agreeing and non-agreeing provinces.
From time to time Ontario has been a non-agreeing province for corporate tax purposes but has now entered into a TCA with the federal government. With the exception of Quebec and Alberta (for corporate income tax only) all of the provinces and territories are now agreeing provinces for personal and corporate income tax. Consequently, the opportunities for exploiting the lack of integration between provincial tax regimes are dwindling but it is still possible based on the Alberta Court of Appeal's decisions in The Queen v. Husky Energy Inc.34 ("Husky") and The Queen v. Canada Safeway Limited35 ("Canada Safeway") and (described below) to shift income to provinces with lower rates of taxation.
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Footnotes
1 Timothy W. Clarke is Of Counsel to Moodys Gartner Tax Law LLP. Kim G. C. Moody is the Director of Canadian Tax Advisory at Moodys Gartner Tax Law LLP. Lisa Handfield is a Tax Lawyer at Moodys Gartner Tax Law LLP
2 A reference to the book titled Future Shock by Alvin Toffler.
3 All references are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended, unless otherwise stated.
4 A person is defined in subsection 248(1) to include a corporation and an individual. A trust is taxed as an individual pursuant to subsection 104(1).
5 Income Tax Regulations, CRC, c. 945.
6 30 & 31 Vict., c. 3.
7 Hogg, Constitutional Law of Canada, 5th ed. ("Hogg"), Carswell at pages 31-32.
8 See Hogg, supra, at page 31-3, Dow v. Black (1875) L.R. (PC) and Re Employment and Social Insurance Act [1936] SCR 427 at page 434.
9 Hogg, supra, at page 25-10.
10 See Bank of Toronto v. Lambe ("Lambe") (1887) 12 App. Cas. 575 and the many Canadian tax cases that cite it.
11 Principles of Political Economy (1848), Book V, chapter 3.
12 See Hogg, supra, at page 31-10 and Nickel Rim Mines v. AG Ontario [1966] 1 O. R. 345 (C. A.); affirmed (1967), SCR 270.
13 Hogg, supra, at page 31-10.
14 See Lambe, supra, at page 582.
15 See Ontario Home Builder's Association v. York Region Board of Education, ("Ontario Home") [1966] 2 SCR 929 at paragraph 126-146 per La Forest J. (concurring in the result).
16 (1912), 45 S.C.R. 469], at p. 536.
17 Hogg, supra, at 31-24.
18 2007 SCC 19.
19 Ibid., at paragraph 12.
20 See Lambe, supra.
21 Hogg, supra, at 31-24.
22 Kerr v. Superintendent of Income Tax [1942] SCR 436.
23 See British Columbia (Attorney General) v. Ellet Estate, [1980] 2 S.C.R. 466.
24 [1980] 2 S.C.R. 303.
25 (1966), 28 O.R. (3d) 97.
26 Under which the provinces surrendered their constitutional right to impose personal and corporate income tax and succession duties in exchange for "tax rental payments" from the federal government.
27 R.S.C. 1985, c. F-8.
28 The TCA were implemented in 1962. The federal government assumes the cost of bad debts as well as the cost of administering the TCA and in exchange the federal government is allowed to retain interest and most penalties levied on taxpayers.
29 Residents of Quebec receive an abatement of 16.5 percent of their basic federal tax but are subject to tax at the prevailing rates set by the Quebec government. Quebec taxes its residents under the Quebec Taxation Act.
30 In 1977 the federal government lowered its tax rates to create more room for the provinces to levy their tax, thus there was minimal effect on the total amount of income tax payable by an individual.
31 2006 MBCA 58 affirming 2004 MBQB 180.
32 RSQ, c. I-3.
33 Section 53.2 of the Act, CCSM, c I-10.
34 Infra, note 115.
35 Infra, note 116.
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