Takeaway: Tax Court finds that interest accrues until the actual date of loss carryback request:
Case Summary: Bank of Nova Scotia v The Queen, 2021 TCC 70
In this recent decision, the Tax Court of Canada was tasked with interpreting paragraph 161(7)(b) of the Income Tax Act (the Act), and the timing of loss carrybacks for the purpose of calculating interest on an outstanding tax balance. When a taxpayer makes a written request to carry back non-capital losses to offset tax payable that arose in a previous taxation year, the Court held that arrears interest accrues from the balance due date of a taxation year to which a loss is applied until the date the carryback request is made. This resulted in a significant cost for the taxpayer due to a carryback request made almost six years after the balance due date.
Facts: The taxpayer was a Canadian bank, with a taxation year ending on October 31. On April 28, 2009, the taxpayer filed its 2008 income tax return and reported a non-capital loss of approximately $4 billion.
During the 2013-2014 calendar years, the CRA performed an audit of one of the taxpayer's foreign subsidiaries and reviewed income tax returns for the tax year-ends 2006 to 2010. In February of 2015, the CRA issued a proposal letter to the taxpayer in respect of the audit of the 2006 taxation year. The parties agreed to enter into a settlement agreement involving certain transfer pricing adjustments to the taxpayer's returns for the period of 2006 to 2014, which would result in an increase to the taxpayer's 2006 taxable income of roughly $54.9 million.
In March of 2015, the taxpayer wrote back to the CRA requesting that $54 million of the non-capital losses that arose in the taxpayer's 2008 taxation year be carried back to offset the increase of the $54.9 million of income that arose in the 2006 taxation year due to the CRA's transfer pricing adjustments.
Shortly thereafter, the CRA issued a notice of reassessment for the taxpayer's 2006 taxation year, whereby the taxpayer's taxable income for 2006 was increased by $54.9 million, in accordance with the agreed-upon terms. Along with this, a corresponding adjustment of the 2008 non-capital loss of $54 million was also carried back and applied to offset the increased income, however, the CRA assessed arrears interest of appropriately $7.9 million, representing interest that accumulated from 2006 to the deemed payment date of March of 2015, the date when the taxpayer requested the loss carryback.
The taxpayer disagreed with the CRA's application and calculation of arrears interest and appealed to the Tax Court.
Issue: At issue was for the Court to decide the deemed payment date for the purpose of calculating arrears interest when a loss carryback is applied.
Tax Court Decision: On appeal, the Tax Court held – based on the specific wording of the statute – that if an amount of tax payable for a taxation year (i.e., the 2006 taxation year) is reduced because of the carryback of losses from a later year (i.e., from the 2008 taxation year), interest on any unpaid tax for the 2006 taxation year is to be calculated as if no reduction occurred until 30 days after the latest of the following dates:
- The first day immediately following the loss year = November 1, 2008
- The day the taxpayer's income tax return for the loss year was filed = April 28, 2009
- If the CRA reassessed the taxpayer's tax for the year to take into account the loss deduction as a consequence of a written request, the day on which the request was made = March 12, 2015
Taxpayer's Argument
The taxpayer's position was that interest arrears should be calculated based on the date that the taxpayer filed its income tax return for the year the loss was filed – April 28, 2009, as opposed to the date on which the loss carryback request was made – March 12, 2015. The taxpayer relied on the authority of the Methanex3 case in support of its position – that interest should be calculated based on the filing date of the loss year return.
CRA's Argument
The CRA's position was that interest should be calculated based on the date on which the taxpayer made its written request for the carryback loss – March 12, 2015. CRA argued that the existence of a loss carryback in a subsequent year does not mean that tax debt from an earlier year was never owed. CRA's position was that the specific language of paragraph 161(7)(b) is clear in that the tax debt of an earlier year is owed until a formal loss carryback request is filed. The CRA relied on the authority of the Connaught4 case in which the Federal Court ruled that where losses are carried back and result in no tax payable, arrears interest continues to accrue on the tax that would have been payable but for the loss carryback until the formal request is made. The Federal Court in that case also found that the wording of the relevant provision was unambiguous and that the CRA's interpretation of it did not contravene the object, spirit or purpose of the Act.
Tax Court's Analysis
The trial judge disagreed with the taxpayer's argument, stating that in a self-assessing system, the onus is on the taxpayer to ensure its taxes are paid on time. Despite the fact that the balance was discovered later during an audit, the taxpayer was liable for tax owing regardless by virtue of the operation of the Act. In other words, a formal assessment issued by CRA is not necessarily determinative of a taxpayer's actual tax liability which is inherently a question of law.
The court agreed with the CRA, in that the current instance was more similar to the Connaught case than the Methanex case, and that Methanex was either wrongly decided or its reasoning could not be applied to an appeal under the federal Income Tax Act. It should be noted that the Methanex case was decided by the Alberta Court of Appeal and related to a provincial taxing statute, not the federal Income Tax Act.
In sum, the court found that the wording of paragraph 161(7)(b) was unambiguous and that Parliament's intention was in accordance with the CRA's position. For these reasons, the appeal was dismissed.
Takeaways
The end result of this case proved to be costly for the taxpayer. One could argue that this interpretation of the provision results in interest accruing on a balance that did not exist, or at the very least existed only for the period until such time as losses became available to be carried back.
Related to this point, the Tax Court noted that the Tax Act contemplates retroactive or retrospective liability following a reassessment in a self-reporting system. However, if a taxpayer does not know about a tax liability until many years later, for example after an audit, it seems unfair that they should have to pay interest for the intervening years.
It is worth noting that in the past, the CRA has acknowledged that the purpose of paragraph 161(7)(b) was to prevent situations where a taxpayer deliberately refused to pay taxes in a year, in anticipation of incurring losses in a subsequent year that could be carried back to eliminate the previous year's tax liability.
Where there were no indications of such tax avoidance, the CRA has in some circumstances be willing to accept that arrears interest should accrue only until the filing date of the taxpayer's loss year tax return, and not until the day of the request for loss carryback. It would thus appear that the CRA has not been consistent over the years in its approach to applying the provision.
Taxpayers who are being audited and may have carrybacks or carryforwards available to offset any potential "new" tax liabilities should consult immediately with a tax lawyer to determine what, if anything can be done to try and minimize this unexpected and often costly expense.
Sources
[1] Bank of Nova Scotia v. The Queen, 2021 TCC 70 (CanLII)
[2] Connaught Laboratories Ltd v. Canada, 1994 CarswellNat 1133 (FCTD).
[3] Alberta (Provincial Treasurer) v. Methanex Corporation, 2004 ABCA 304 (CanLII), affirming Methanex
[4] Corp v. Alberta (Provincial Treasurer), 2003 ABQB 157 (CanLII)
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