Canada: CRA Decision Successfully Challenged In Pomeroy's Masonry Limited V. A.G. Canada

Last Updated: November 28 2017
Article by Douglas Wright


Under subsection 164(1) of the Income Tax Act, a corporation must file its tax return within three years of the end of the taxation year to be entitled to receive a tax refund, should one arise on assessment by the Canada Revenue Agency. The harshness of tax refunds being statute-barred for corporations, if a tax return is not filed three years after the end of the taxation year, has been the subject of commentary for several years, including a recent written submission by CPA Canada to the Department of Finance.

The only avenue a corporate taxpayer has to get at least partial relief when a tax refund is statute-barred under subsection 164(1) is to ask the Minister of National Revenue under section 221.2 of the Income Tax Act to take the credits in the corporate income tax account that cannot be refunded with a payment, and apply them to another tax debt that is payable or will become payable by the corporation, i.e., to apply the credits to the corporation's tax debts, whether on account of income tax, payroll tax or HST.  Whether or not a re-appropriation of statute-barred credits under section 221.2 of the Income Tax Act will be allowed is left to the discretion of the Minister of National Revenue. In other words, taxpayers making the request do not have a right to have their statute-barred refunds re-appropriated.

Most taxpayers are aware that if they are eligible for a tax refund that is not statute-barred while having other tax debts outstanding, the CRA would not issue them a tax refund; the CRA would automatically apply the refund otherwise payable to the taxpayer to their outstanding tax debts.  Why would the treatment not be the same for a statute-barred refund? However in recent years, the CRA has adopted a restrictive policy around when it will exercise the discretion to re-appropriate tax balances in favour of taxpayers. 

The Common Scenario

The problem of the stranded corporate income tax refund may arise when a corporation does not file its income tax return on time and receives an "arbitrary assessment" from the Canada Revenue Agency. Arbitrary assessments by the Minister are a necessary element of the self-assessment income tax system to deal with non-filers. Naturally, the Minister has the right to collect taxes that are imposed under an arbitrary assessment.  However, once an arbitrary assessment is issued, the taxpayer has three years from the date of the arbitrary assessment (not the taxation year-end) to file a tax return to request that the Minister make a reassessment of the taxpayer's year.  Typically this "normal reassessment period" during which a tax return can be filed will be longer than the period of time that the corporation has to file a return and be entitled to a refund.

Pomeroy's Masonry (Represented by Cox & Palmer)

Pomeroy's Masonry Limited is a small business that was late in filing its tax returns for the 2006, 2007 and 2008 taxation years.  The Minister of National Revenue exercised the powers under the Income Tax Act to make arbitrary assessments and imposed income tax, interest and penalties against the corporation which totaled almost $100,000.  The CRA then collected more than $100,000 through payments from Pomeroy's and amounts garnisheed from third party payments to Pomeroy's, and applied these funds to the arbitrary assessments. When Pomeroy's filed its tax returns in 2012, it was still within the "normal reassessment period" for the 2007 and 2008 taxation years. The CRA reassessed for 2007 and 2008 based on the late filed tax returns and found that Pomeroy's had no taxable income in either year; on reassessment the CRA reversed all of the taxes, penalties and interest that had been previously assessed for those two years. There was also a consequential loss carryback to reduce tax payable in 2006. However, any tax refund that would otherwise follow from the reassessments was statute-barred by subsection 164(1) of the Income Tax Act.

The CRA did re-appropriate $55,000 of the statute-barred credits on the basis that the CRA had collected that amount to be paid into Pomeroy's payroll tax account but misapplied the payments to its corporate income tax debt under the arbitrary assessments. With respect to the remaining $45,000 of statute barred refunds, the Minister refused Pomeroy's request to apply that amount to Pomeroy's HST arrears. Under its policy which is now incorporated into the Canada Revenue Agency form for applications under section 221.2, the CRA imposed an onus on Pomeroy's to show "extraordinary circumstances beyond the taxpayer's control" such as flood, fire or serious illness, which prevented the timely filing of its income tax returns.

Because Pomeroy's did not provide adequate justification for why it did not file its corporate tax returns before the time when a refund would be statute barred under subsection 164(1) of the Income Tax Act, the Minister of National Revenue refused to apply the approximately $45,000 in statute-barred refunds to Pomeroy's HST arrears. Without such a re-appropriation, Pomeroy's statute-barred tax refunds were effectively stranded, while Pomeroy's remained under an obligation to get caught up with its HST arrears.


In his decision, Justice Southcott found that the Minister's refusal was unreasonable on the basis that the Minister did not consider any other factors connected to Pomeroy's request other than whether or not "extraordinary circumstances" were shown.  With specific reference to Pomeroy's request, it did not appear that the Minister gave consideration to Pomeroy's explanation as to the financial hardship that would be caused to the company by a refusal to apply the stranded income tax credits to its HST debt or the resulting possibility that the company would not be in a position to pay its HST debt if its statute barred credits could not be re-appropriated for this purpose. 

There were other factors submitted to the Court that Pomeroy's argued were ignored by the Minister in Pomeroy's case; one in particular was the very high amount of income attributed to Pomeroy's under the arbitrary assessments, which bore no resemblance to its reported income in any taxation year.  In his decision Justice Southcott did not consider it necessary to point out any other factors other than the Minister's failure to address Pomeroy's representations as to financial hardship and its ability to pay its HST liability.

Impact of the Decision

Undoubtedly, taxpayers have difficulty with the idea that a tax refund can be lost if they do not file a tax return within three years. The anxiety is then compounded when the government refuses to re-appropriate what the taxpayer feels is their money towards their tax debts, if it cannot lawfully be paid to them in the form of a tax refund.

Justice Southcott's decision is not based on any of these criticisms; rather it is founded on principles of administrative law that apply to the exercise of all forms of ministerial discretion.  Notwithstanding that the CRA policy does state that there may be unspecified situations besides extraordinary circumstances where relief under section 221.2 will be justified, it is clear that the Canada Revenue Agency cannot limit decisions under section 221.2 of the Income Tax Act to an inquiry of whether "extraordinary circumstances" rendered the taxpayer unable to file a tax return before the time any refund would be statute-barred.  While the existence of extraordinary circumstances would obviously be a consideration in the taxpayer's favour, it is unacceptable in the eyes of the Court that this be made a singular requirement for relief under section 221.2.

Pomeroy's Masonry is the second case this year in which a denial by the CRA of a taxpayer request under section 221.2 of the Income Tax Act was set aside by the Federal Court on judicial review. In Cybernius Medical Ltd. v. Canada (Attorney General) the Federal Court quashed a denial by the Minister of National Revenue of the taxpayer's request to re-appropriate nearly $600,000 in statute-barred credits in its income tax account to the arrears in its payroll tax account. In finding for the taxpayer, the court held it was unreasonable for the Minister not to exercise the discretion to re-appropriate under section 221.2 of the Income Tax Act to ensure the collection of the payroll source debt by using an existing tax credit. Justice McVeigh stated it would be counter to the purpose of the Income Tax Act for the Minister to refuse the request, especially given the importance of statutory source deductions under other Acts of Parliament.

In both the Cybernius and Pomeroy's Masonry decisions, it is accepted by the Court that the payment of tax debts is an important part of the purpose of section 221.2. It will be interesting to see whether these decisions will cause the CRA to revisit their administrative policy as a result.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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