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Timestamp: 2019-04-22 20:22:24+00:00

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Ruminations of a Toronto Tax Lawyer: Should there be a judicially-created due diligence defence on the reporting of significant foreign property?
Should there be a judicially-created due diligence defence on the reporting of significant foreign property?
The following was co-authored with Darcy MacPherson and is published on TaxnetPro. The article discusses whether a taxpayer can claim a due diligence defence for the failure to file Form T1135 - Foreign Income Verification Statement. We argue no.
Since 1997 subsection 233.3(3) of the Income Tax Act(“Act”) mandates that Canadian resident taxpayers are required to file Form T1135 - Foreign Income Verification Statement - with their income tax returns where such taxpayers own specified foreign property with a cost amount of 100,000 or more. Form T1135 is not required where the foreign property is personal property such as vacation property used by the taxpayer or personal property such as work of art, jewelry, rare books, stamps and coins. Failure to file Form T1135 will subject the taxpayer to a penalty of $25 a day up to a maximum of 100 days pursuant to subsection 162(7) of the Act. There is no indication on the language of the statute that there is a defence of due diligence available when a taxpayer is late in filing this form. Yet, in a recent case, Tax Court Judge Woods has clearly decided that the judiciary has the final say on the application of penalties.
In the view of the authors, there are problems with such an interpretation, on at least four levels. First, as a matter as interpretation of taxing statutes, it is said that the taxpayer is always free to order his or her affairs so as to avoid liability to tax. Thus, where a taxpayer does not do so, it lies ill in the mouth of the taxpayer to cry foul after litigation has commenced. Second, as a matter of stare decisis, the case does not address other cases that have confronted the issue. Third, as a factual matter, it is difficult to say how due diligence can be made on the facts of the particular case, or more generally. Fourth, there are legitimate reasons that explain why a strict interpretation – meaning that the due diligence defence is unavailable in the case of a deliberate non-filing of the form – is preferable, from a policy perspective.
 Although the penalty in subsection 162(7) is strict and Parliament has not provided for a due diligence defence, this Court has held that even strict penalties should not be applied if a taxpayer has taken all reasonable measures to comply with the legislation: Home Depot of Canada Inc. v. The Queen, 2009 TCC 281.
 It has been my view that the judge-made due diligence defence should be applied sparingly. However, this is an appropriate case in which it should be applied.
While Tax Court Judge Woods claims that the defence should be “applied sparingly”, there is little to distinguish the facts of this case from that of those of many others. For example, the Court says that it is “common knowledge in Canada” that a tax return can be filed late without negative consequences to the taxpayer if no tax is payable, by virtue of subsection 162(1) of the Act (para. 11). The T1135 form says that the form is be filed with one’s tax return (para. 12). To expect professional advice to be sought in these circumstances would not have been reasonable (para. 16). The logic of Her Honour seems to be that the imposition of the penalty is inequitable, and that this inequity should not be visited upon the taxpayer.
Since 1935, it has been a basic principle of English and Canadian tax law that a taxpayer may organize his or her affairs in a way that seeks to avoid the application of tax. See I.R.C. v. Duke of Westminster,  A.C. 1. From the point of view of the authors, the necessary corollary to this principle is that, if a taxpayer organizes his or her affairs in such a way that he or she is obligated by the rules to greater tax, or to make payments or other remittances to the government at a particular time, the taxpayer should be in no position to complain that had he or she organized his or her affairs in a different way, he or she would not have ben liable to these obligations.
This principle has been recognized by the drafters of the GAAR provision of the Act. According to the Explanatory Notes to the GAAR provision subsection 245(3), Parliament recognized the Duke of Westminster principle that tax planning with the objective of attracting the least possible tax is a legitimate and accepted part of Canadian tax law.
On the facts of Douglas, this would seem to suggest that since the taxpayer “made his bed” by not filing on time, he should not be allowed to avoid “lying in it”, that is, by paying the penalty.
Under the informal procedure, used in the Douglas case, the decision of the Tax Court Judge has no precedential value. Therefore, it is clear that the Douglas case is not precedent-setting for future cases. However, this is not the end of the issue of stare decisis. Just because the Douglas case has no precedential value in future case cannot be read to allow the judge in Douglas to ignore prior cases.
It is virtually beyond debate that stare decisis has two components. The first is horizontal stare decisis; the second is vertical stare decisis. In terms of vertical stare decisis, this is the basic rule that a lower court is bound to follow the decisions of any court that is directly above it in the judicial hierarchy. However, as far as the authors can tell, there are no higher court decisions that specifically contradict the holding in Douglas. Therefore, vertical stare decisis is not really at play here.
Horizontal stare decisis, on the other hand, is a critical component of this discussion. This element essentially holds that the Court as an institution should be relatively consistent in its application of the law. In other words, one member of a court should not lightly depart from a precedent established by another member of the same court. The authors have already written on this topic, in discussing the case of The Queen v. John H. Craig, a case with respect to which an appeal was heard by the Supreme Court of Canada on March 23, 2012. There is no need to repeat ourselves. Below, we discuss both some recent case law dealing with the application of subsection 162(7) of the Income Tax Act, and the case of Home Depot Canada, on which Tax Court Judge Woods relies in reaching her decision. In the view of the authors, the doctrine of stare decisis does not necessarily mean that there can be no change in the law. However, in the Douglas decision, Her Honour paid insufficient attention to stare decisis in focussing her attention on the Home Depot case.
"No penalty will be assessed where it appears there was confusion concerning obligations and it is the first time a penalty is considered."
The Applicant submitted that if there was confusion with respect to the rules, then the CRA should have been more lenient about penalties. At the very minimum, the CRA should have accepted that the Applicant's representative was interpreting the rules in good faith, relying on accurate and timely reports being made to the CRA by money managers. It wrote: "The conclusion was wrong, but that does not detract from the reasonableness of the belief that the forms did not have to be filed."
In my view, the Minister's delegate's reasons responded to the facts before him. He characterized the decision as a conscious decision by the Applicant's representative or the Applicant, one that was lacking due diligence rather than confusion. I find the reasoning draws a conclusion that was within the range of possible outcomes defensible on the facts. Moreover, since section 220(3.1) of the does not obligate the Minister to provide relief, the decision was clearly defensible in respect of the law as well as the facts.
Therefore, even though there was a specific program in place at the time to provide relief in appropriate circumstances, the Court indicated that the “confusion” on the part of the taxpayer was not attributable to a lack of clarity by the taxing authorities. Rather, it was due to a lack of diligence by the taxpayer in fulfilling its obligations.
It must be acknowledged that in Asper, the Court was engaged in a substantive review of the decision of an official (the “Minister’s delegate”) in an administrative-law context. Also, the Court was reviewing the decision on a standard of reasonableness. However, if the law demanded a due diligence defence on these facts, and the Minister’s delegate failed to even consider this issue, the authors would argue that the decision of the Minister’s delegate would have been unreasonable. Given the result of the case, therefore, the sole conclusion to be drawn is that the due diligence defence is not available on these facts. Therefore, given the similarity between the facts of this case and those presented in Douglas, if the due diligence defence was not available in Asper, there is little to distinguish Douglas and thus the same result should follow in the subsequent case.
The facts of Leclerc v. Canada, 2010 TCC 99 are even more similar to the Douglas case. In Leclerc, the taxpayer has an expensive condominium in France, and did not report this in two non-consecutive years (2003 and 2006). More accurately, because the taxpayer did not file his tax returns on time, the Forms T1135 for those years were also filed late. From his other tax returns, the government knew that the taxpayer had this property (para. 12). Though other factors were alleged to have contributed to his late filing, notably his studies and mental illness of his mother (see para. 9), Tax Court Judge Favreau upheld the imposition of the penalty. This is also despite the fact that the administrative program that would have provided relief to the taxpayer had been withdrawn earlier by the taxing authorities, without notice to the taxpayer, even though the Agency knew that the change would affect him (para. 11). As in Douglas, the total penalty was significantly higher than the total tax payable by the taxpayer for the years in issue (para. 13). Nonetheless, the penalty was found to be appropriate.
In the end, therefore, the courts that had considered this issue prior to the Douglas decision found that the due diligence defence (even if there were one) had no application on facts similar to those before Tax Court Judge Woods.
Interestingly, Tax Court Judge Woods does not even refers to either Asper or Leclerc. Instead, Her Honour chooses to rely on the case of Home Depot of Canada Inc. v. Canada, a decision of Tax Court Judge Miller. In this case, Deloitte Tax LLP was a company hired by the taxpayer to make its tax returns and other tax remittances, including the remittance of Goods and Services Tax collected pursuant to the Excise Tax Act, RSC 1985 c E15. The remittance was sent to the wrong address by Deloitte. The taxing authorities sought to impose a penalty for the lateness of the remittance.
The CRA may accept a due diligence defence in a situation where a person remits or pays an amount that is less than the amount actually owed where that amount was arrived at after having made an incorrect assumption based on genuine uncertainty regarding the application of the ETA. In addition, in a situation where a person is a recipient who fails to report and remit the tax on a self-assessment situation and this failure can be attributed to an incorrect assumption based on genuine uncertainty over the application of the ETA, a due diligence defence may be accepted by the CRA. Also, the CRA may accept a due diligence defence where a person believed on reasonable grounds in a non-existent fact situation, which if it had existed, would have made the person's actions or omission innocent; that is, the person relied on a reasonable but erroneous belief in a fact situation. In any case, for a person to be duly diligent it must be clearly evident that despite making an incorrect assumption, or having an erroneous belief in a fact situation, all reasonable care has been taken to the best of the person's ability in ensuring that the correct amount was remitted or paid, and the return filed, when required.
The CRA would not generally accept a due diligence defence where the correct amount was paid or remitted after the due date. In particular, where the CRA determines that a person has complied with the obligation to collect the correct amount as required but has failed to remit this amount when required, the person's due diligence defence would not be accepted. It is the CRA's position that a person who has failed to take reasonable care to ensure that the correct amount was paid or remitted by its due date, has not exercised due diligence.
In Home Depot, the taxing authorities themselves had produced guidelines indicating that when a late remittance occurred notwithstanding the due diligence of the taxpayer, the penalty for such a late remittance would not be imposed. These same guidelines continue on to explain what would be considered “due diligence” for the purposes of these guidelines, as well as what would generally not qualify. With all due respect to Her Honour, this is in sharp distinction to the facts of Douglas. There was no specific guidelines for a finding of due diligence mentioned in any of the cases involving the application of subsection 162(7). Furthermore, in Home Depot, there was a genuine attempt on the part of the taxpayer at issue to comply with the requirements of the relevant statute on time. In Douglas, the belief was not that he was making a genuine attempt to comply, but rather, the error was that the taxpayer believed that non-compliance would attract no negative consequences. The authors discuss this issue in greater detail in the section immediately below. For current purposes, however, it is sufficient to note the following. Home Depot arose under a different statute, with non-statutory guidance provided by governmental authorities (that the due diligence defence was potentially available, and the circumstances under which the defence was likely to be successfully invoked), and with a very different factual scenario (in that there was a genuine attempt by the taxpayer to comply with the statutory requirements). These differences make it difficult for the authors to see why the Home Depot case is more persuasive than is either Asper or Leclerc.
 In this case, Mr. Douglas was not cavalier about his income tax obligations. As far as the evidence reveals, he was diligent in his compliance efforts and he acted reasonably, and competently. It was not suggested by the respondent that there was information readily available to Mr. Douglas that would have alerted him to this problem.
However, with all due respect to Her Honour, the authors have great difficulty with this holding. With respect to the last sentence, the Act itself draws the distinction. The distinction was not “buried” in a regulation that could not be found without special skills, nor located in an administrative bulletin not easily accessed without professional assistance. The matter is evident on the face of the Act itself.
While it is true that the Form itself says that it is to be filed “with your tax return”, the Form is very short (two pages). Therefore, to fully explain the expectations of the taxing authorities in a variety of circumstances, including the particular scenario of a tax return where no tax would be payable could add significantly to the size and complexity of the form. Forms should not be more complex than necessary.
The essence of the claim of the taxpayer is not that the taxpayer attempted to comply with his obligations under Income Tax Act. On the contrary, in past years, the taxpayer had not submitted his tax documentation until well after the applicable deadline. This implies that the taxpayer knew what the deadline was, and thus knew what his obligations were. In the view of the authors, the taxpayer’s real complaint was that he was ill-informed as to the consequence of shirking his obligations. In past years, there had been no real negative consequence to the late filing. The taxpayer assumed that this treatment of his late filing would continue. It did not. Rather, the administrative indulgence previously granted in situations such as that involving Mr. Douglas was changed. This in and of itself is not sufficient to ground a remedy. Although taken from a different context (notably the law of promissory estoppel in the law of contracts), the case of John Burrows Ltd. v. Subsurface Surveys Ltd., per Justice Ritchie, for the Court, is instructive. The granting of an indulgence, even on multiple occasions, does not, in and of itself, change the legal relationship between the parties.
 The appellant made an honest mistake because he did not know the consequences of failing to file form T1135 by the due date. The penalty under subsection 162(7) of the Act was imposed correctly, and the due diligence defence is not applicable in this case.
 It is not so much being subject to the penalty under subsection 162(7) of the Act that poses the problem as the lack of statutory provisions setting out a defence that does not require you to use a program that was not designed to deal with a simple late filing of a form. That is obviously a matter for Parliament. The same observation could be made with respect to the quantum of the penalty; Parliament could consider providing relief to take into account cases similar to the appellant's where the penalty is disproportionate to the tax otherwise payable.
In the view of the authors, everyone (the Asper companies, Mr. Leclerc, Mr. Douglas, the judges involved and the taxing authorities) seems to accept that the penalty provided for under subsection 162(7) of the Act is meant to be strict. As Tax Court Judge Favreau points out in Leclerc, there are no problems of interpretation in the section (para. n). In the view of the authors, this is accurate. Each of the taxpayers involved sought relief from the consequences of the late filing. It is one thing for judges to point out to the legislature the potentially undesirable effects that a particular provision are having. In the view of the authors, it is quite another for the court to appropriate to itself the ability to countermand the directive of the legislature. There is undoubtedly a degree of statutory construction in this exercise. But, the Court acknowledges (i) the strict nature of the penalty and (ii) that Parliament could have provided for a due diligence defence and did not do so. Therefore, this is not construction of the statute; this is judicial alteration of its express, and therefore, ignorance of the will of the legislature. In the view of the authors, this cannot be countenanced.
(ii) $25 times the number of days, not exceeding 100, from the day on which the return was required to be filed to the day on which the return is filed.
Clearly, then, for a non-resident corporation, the penalty for the failure to file on time is determined by both (i) the amount of tax due and payable; and (ii) the lateness of the performance of the filing obligation. Why would this be so? The Income Tax Act clearly treats non-residents differently than it does residents of this country, both in terms of their substantive obligations to tax (in terms of for example the availability of deductions), and their reporting obligations.
When it comes to the latter, in the view of the authors, this is quite logical. With respect to residents and their property within Canada, information may be obtained from a variety of sources. Municipal tax records and provincial records with respect to land transfers (and other major purchases, such as motor vehicles) come to mind in this regard. Similar records for foreign jurisdictions are not as easily accessible by Canadian authorities, if they exist at all. Therefore, there must be a significant incentive for the major source of information with respect to the foreign assets to make full disclosure. The major source is the taxpayer him- or herself.
Given that in all three of the cases referred under subsection 162(7) were situations where no tax revenue was lost, are there other practical reasons why the penalty would need to be a possibility? The concept of “out of sight, out of mind” is one potential reason. By definition, the subsection is concerned with residents. Residents spend more than half their time in Canada. Yet, the property at issue is both high in value and elsewhere. Many people have a tendency not to focus attention on material that they do not use on a regular basis. It is unsurprising that the government decided to make reporting an annual requirement, regardless of the income produced by the property at issue. By regular reporting, “out of sight, out of mind” is less likely to occur. To make reporting truly regular in this sense, the need to report has to be independent of the income earned by the taxpayer, either from the foreign property or otherwise.
3. Duly Diligent in a Non-Filing?
As mentioned above, it is very difficult for the authors to accept the idea that a lack of action on the part of the taxpayer is a show of due diligence. As a general rule, diligence requires active participation in the activity concerned. In Soper v. Canada,  1 F.C. 124 (C.A.), Justice Robertson considered the use of the due diligence defence found subsection 227.1(3) of the Income Tax Act. The section deals with the liability of corporate directors for the making of remittances of source deductions from the wages of employees. In the case, a company, RBI, did not make its source deduction remittances. Soper was an experienced businessman. He claimed that there was a “conspiracy of silence” to avoid his learning of the fact that remittances were not being made (para. 58). The Court held that Soper was aware of financial difficulties for RBI. Therefore, this knowledge meant as a director, Soper was under an obligation to ask about whether remittances were being made. In other words, diligence required that the director not make an assumption in the face of cause for concern, but to take an active role in ensuring that the obligation is met.
It is true that parts of the decision in Soper were questioned in the case of Peoples Department Stores Inc. v. Wise,  3 SCR 461. Nonetheless, the principles referred to were not questioned. In fact, the main point of contention in the Supreme Court of Canada was whether there was a subjective component in the due diligence defence. The Federal Court of Appeal was of the view that there was a degree of subjectivity; the Supreme Court of Canada that the standard entirely objective under the duty of care for corporate directors (which used the same wording as the due diligence defence under subsection 227.1(3)). If anything, the lack of a subjective element makes the due diligence harder to use than provided for in the Federal Court of Appeal’s decision in Soper.
In the view of the authors, even to the extent that a due diligence defence should be read into subsection 162(7), the judicially created due diligence defence should be no less rigorous than its statutory counterpart within the same statutory framework. In other words, Mr. Soper could not rely on the due diligence defence because he was not active enough in light of what his knowledge. In the same way, Mr. Douglas knew that he had significant foreign property. In light of this knowledge, doing nothing with respect to reporting the significant foreign property to the government is not duly diligent on the part of Mr. Douglas.
In the end, the authors believe that it is problematic to imply a due diligence defence where the Court acknowledges that the intention of Parliament was to the contrary. Such an approach is in the view of the contrary to the prior case law that considers the imposition of penalties under subsection 162(7). Complete inaction by the taxpayer will rarely be duly diligent. This view is also consistent the approach take to the statutory due diligence defence within the Income Tax Act. Finally, the need for information from the taxpayer makes the imposition of the penalty a meaningful incentive for the taxpayer to be forthcoming about his or her significant foreign property. This serves a legitimate practical purpose, and the decision of Tax Judge Woods in Douglas undermines this purpose to an extent. Therefore, in the view of the authors, the decision in Douglas is highly questionable.
** Associate Professor, Faculty of Law, University of Manitoba, Winnipeg, Manitoba.
The cost amount is defined in subsection 248(1) as the cost based. It is not the fair market value of the asset. For new immigrants to Canada, the cost amount is equal to the fair market value of the property at time of entry into Canada.
 As will be seen in the case law section below, this is not in fact technically correct. Prior to the formation of the Tax Court of Canada, the Tax Appeal Board was the initial level of appeal for decisions of the various predecessors of what is now known as the Canada Revenue Agency. From the Tax Appeal Board, an appeal was available to what was then known as the Federal Court, Trial Division (now the Federal Court of Canada). Currently, an appeal lies from the Tax Court of Canada to the Federal Court of Appeal. Therefore, currently, there is no direct appeal from the Tax Court of Canada to the Federal Court of Canada. Nonetheless, due to this historical reality, the Federal Court is viewed in some quarters as being above the Tax Court of Canada. However, beyond this short explanation, the authors will not focus on this distinction.
 On this point, please see Sunita Doobay and Darcy L. MacPherson, “Craig and Stare Decisis” Canadian Tax Highlights, (a publication of the Canadian Tax Foundation) Volume 20, No. 2 (February, 2012), at 2-3 and Sunita Doobay and Darcy L. MacPherson, “Gunn & Craig – Hobbies, Farms and Stare Decisis” (TaxNetPro and The Tax Practitioners’ Forum, January 2012) at 1.

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