Current Issues Forum: Pipeline Planning; Section 159 Clearance Certificates; Charitable Sector; and Non-Profit Organizations

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1 Current Issues Forum: Pipeline Planning; Section 159 Clearance Certificates; Charitable Sector; and Non-Profit Organizations INTRODUCTION Chris Falk 1 This paper addresses a number of legislative and administrative developments in the income tax area that are not addressed in detail in other sessions of the 2011 British Columbia Tax Conference. The paper is a companion piece to the paper on current issues presented at the conference by Amanjit Lidder. The paper addresses four broad topics that are of current interest to income tax practitioners in light of proposed legislative changes or administrative or interpretative positions taken by the Canada Revenue Agency (the CRA ). In respect of the topics addressed, the authors note as follows: Pipeline Planning Pipeline planning, described below, has for many years been one of the basic tools employed by tax practitioners to relieve against double taxation where shares of a private corporation have been deemed by the provisions of the Income Tax Act (Canada) (the Act ) 2 to be disposed of for proceeds of disposition equal to their fair market value ( FMV ) upon the death of a taxpayer. Such planning has generally been considered by planners to be non-controversial and consistent with the overall scheme of the Act. However, over the past couple of years, and more explicitly over the past year, the CRA has taken the position that very standard pipeline planning may give rise to a deemed dividend to the estate of the deceased taxpayer pursuant to the provisions of subsection 84(2). In the authors view, the CRA s position is likely wrong as a matter of law. The paper comments generally on the manner and the circumstances in which pipeline planning has typically been employed, outlines recent comments by the CRA in respect of pipeline planning, and comments on the CRA s position in light of the provisions and the scheme of the Act. Section 159 Clearance Certificates Subsection 159(2) requires generally that a legal representative of a taxpayer obtain a certificate from the Minister of National Revenue (the Minister ) certifying that taxes and other amounts payable by the taxpayer pursuant to the Act have been paid (or security provided therefore) before property is distributed by the legal representative. 1 2 The authors note that the views expressed in this paper are their own and do not necessarily represent the views of. Except as otherwise noted, all section references are to the provisions of the Act and all monetary references are to Canadian dollars. 1

2 Subsection 159(3) provides generally that a legal representative who fails to obtain a clearance certificate prior to distribution becomes personally liable to pay the taxpayer s taxes and other amounts payable under the Act. The provisions of subsections 159(2) and (3) and the position taken by the CRA that it will not normally issue a clearance certificate until the taxpayer s final return has been assessed typically result in a Catch 22 (i.e., property cannot be distributed until a clearance certificate has been issued but until all property has been distributed a final return of a taxpayer cannot be filed or assessed). Consequently, tax practitioners have come to rely extensively on administrative practice in respect of the requirements of section 159. However, there has been little discussion of the myriad of technical interpretations and other releases that have been published by the CRA regarding this and other issues relevant in respect of section 159 clearance certificates. In addition, over the past year or so, the CRA has issued a number of noteworthy technical interpretations and the Tax Court of Canada has dealt with an assessment issued under subsection 159(3) that might suggest that the CRA is becoming more aggressive in seeking to impose personal liability on a taxpayer s legal representatives. This paper comments upon the requirements of subsections 159(2) and (3), and upon many of the administrative positions, including recent ones, taken by the CRA. Charitable Sector The 2010 federal budget contained very important measures affecting the charitable sector, which measures were principally relieving in nature and which, generally, greatly simplified the disbursement requirements applicable to registered charities. The 2011 federal budget also focussed on the charitable sector with a host of proposed new provisions. Unlike the 2010 changes, however, the 2011 proposals seek generally to tighten the rules applicable to registered charities and similar entities able to issue official donation receipts (collectively referred to as qualified donees ). This paper comments upon the various proposals from the 2011 federal budget applicable to qualified donees. Non-Profit Organizations The Act contains a very broad and simple exemption from income tax for a range of clubs, societies and associations described in paragraph 149(1)(l) and commonly referred to by practitioners as non-profit organizations ( NPOs ). Over the past couple of years, the CRA has issued a number of technical interpretations and other publications as to the activities that may cause an NPO to lose its tax exempt status. Many in the tax community believe that these CRA publications are much more restrictive than the relevant jurisprudence. Over the past year, the CRA has issued a number of additional publications in respect of this issue. These more recent publications may represent a subtle shift or refinement in the CRA s views as to the activities that an NPO can undertake. These recent publications, in any case, help to clarify the CRA s position in respect of this issue. 2

3 The paper comments on the requirements in the Act applicable to NPOs and the CRA s position on this issue, with particular focus on the CRA s most recent publications. PIPELINE PLANNING Background Post-Mortem Tax Planning Various post-mortem tax planning techniques have been developed and refined over the years to relieve against double taxation that can arise under the Act as a result of the deemed disposition on death. In a situation in which an individual dies owning shares of a private corporation, 3 the shares (as well as other properties owned by the deceased) are generally deemed to be disposed of by the deceased immediately prior to death at their then FMV (in the absence of a rollover to a spouse or spouse trust). 4 Accordingly, where the FMV exceeded the adjusted cost base ( ACB ) 5 to the deceased, a capital gain will be realized in the deceased s terminal year. As a consequence of the deemed disposition at FMV, where the shares of the private corporation are acquired by a person (e.g., the deceased s estate 6 ), that person is deemed to acquire the shares at a cost equal to the FMV immediately before death. However, this deemed disposition does not vary the ACB of the assets owned by the corporation itself or permit assets to be distributed from the corporation to its shareholders without additional shareholder level tax. Accordingly, in the absence of tax planning, the same economic gain that was taxed in the hands of the deceased can be taxed again in the hands of the corporation (and its shareholders) when its assets are ultimately disposed of (and the net proceeds distributed to shareholders), giving rise to economic double taxation. The three principal techniques for relieving against this form of double taxation are: Capital loss carryback planning, using the provisions of subsection 164(6) to create a loss in the deceased s estate within the estate s first taxation year, which capital loss the Act permits to be used to offset the capital gain arising on death; Bump planning, using the provisions of paragraphs 88(1)(c) and (d) on a winding up into a new corporation that acquires all of the shares of the corporation the shares of which were owned by the deceased taxpayer (and which have a high ACB to the estate), to increase the ACB of non-depreciable capital property owned by the corporation; and Pipeline planning, in which a new corporation is used to create a so-called pipeline of debt or high paid-up capital shares that allows assets to be distributed to the estate or beneficiaries of the estate without additional tax payable by the recipient These comments assume that, as would normally be the case, such shares were capital property of the deceased taxpayer for purposes of the Act. Subsection 248(1) and section 54 define what constitutes a taxpayer s capital property. Subsection 70(5) provides for the deemed disposition of capital property at FMV; subsection 70(6) generally provides for a rollover to a spouse or spouse trust. The rollovers in section 70 for family farming corporations and family fishing corporations transferred to children of a deceased are ignored. Subsection 248(1) and section 54. More precisely, the deceased s executor or executrix in his or her capacity as executor or executrix. 3

4 These techniques are sometimes used independently but often combined with a view to optimizing the after-tax result. How and When a Pipeline is Used Capital loss carryback planning typically involves the winding-up of the corporation owned by the estate, or a redemption (or purchase for cancellation) of its shares owned by the estate, within the first taxation year of the estate. In effect, pursuant to the provisions of subsection 164(6), the capital gain realized on the deceased s death can be offset wholly or in part by a capital loss triggered in the estate s first taxation year on the winding-up or share redemption, and deemed dividends are received by the estate. While the winding-up or redemption of shares may trigger corporate level tax on the disposition of assets, and deemed dividends to the shareholders, where such dividends can be paid on a tax-efficient basis (e.g., paying capital dividends out of the corporation s capital dividend account or paying dividends that give rise to a dividend refund to the corporation), capital loss carryback planning is frequently beneficial. 7 However, if dividends cannot be paid on shares of a private corporation on a tax-efficient basis, a pipeline strategy may be more effective, particularly if the corporation in question has cash or other assets with nominal gains associated with them (or where a bump can be used to increase the ACB of non-depreciable capital assets). Pipelines may be particularly attractive in British Columbia where there is a very substantial difference between the highest marginal rate applicable to an individual on capital gains (i.e., 21.85%, given the 50% inclusion rate on capital gains and the top marginal rate of 43.7%) and on dividends that are not eligible dividends (i.e., 33.71%). 8, 9 Pipeline planning can be illustrated using the following simple example: 10 Mr. X dies owning all of the shares of a private corporation, XCo; The shares of XCo were held by Mr. X as capital property for purposes of the Act and had an ACB to Mr. X of $100,000 and an FMV immediately prior to Mr. X s death of $1,000,000. Accordingly, the deemed disposition of the XCo shares would give rise to a $900,000 capital gain in Mr. X s terminal year (assuming no rollover to Mr. X s spouse or to a spouse trust); To create a pipeline, Mr. X s estate would incorporate a new corporation, Holdco, for nominal consideration. The estate would sell the shares of XCo to Holdco for $1,000,000 (assuming no accrued gain or loss in the estate since Mr. X s death). 11 The While outside the scope of these comments, it is noted that capital loss planning involves complying with a significant number of stop-loss and other technical rules. The highest marginal rate on eligible dividends is 23.91% in BC for Private corporations that are or were formerly carrying on business and that have significant retained earnings (that did not give rise to capital dividends or to refundable tax) are often corporations in respect of which pipeline planning can be attractive. XCo and Holdco, referred to below, are assumed to be taxable Canadian corporations (subsections 248(1) and 89(1)). A section 85 rollover could, of course, be used if there were an accrued gain in the hands of the estate. 4

5 sale proceeds payable by Holdco would be a non-interest bearing demand promissory note payable by Holdco in the amount of $1,000,000; 12 XCo would be wound-up into Holdco on a tax-deferred basis; 13 Holdco would use cash on hand (or other assets with only nominal gains) to repay all or part of the promissory note held by the estate. But for recent comments from the CRA suggesting that such a transaction might trigger a deemed dividend to the estate, tax practitioners had generally understood that the estate would receive proceeds on the promissory note on a tax-free basis given that the promissory note would have an ACB to the estate equal to its face amount. CRA s Position Regarding Pipelines Concern that the CRA might take the position that a basic pipeline such as that described above could give rise to a deemed dividend to the estate pursuant to subsection 84(2) was raised in a CRA Round Table at the 2009 APFF Conference. 14 In the round table, the CRA did not take the position that subsection 84(2) applied in the example considered but, rather, declined to comment on the possible application of subsection 84(2) in the absence of more detailed facts than had been provided. The example considered in the round table assumed that a taxpayer, immediately prior to death, owned all of the shares of a taxable Canadian corporation, ACo, which had an FMV of $100,000 and an ACB of $100. ACo was assumed to have cash of $100,000, no liabilities, $100 in capital stock and $99,900 in retained earnings. Given the lower rates applicable to capital gains, it was proposed to use a pipeline in which the shares of ACo would be sold to a new taxable Canadian corporation, BCo, incorporated by the estate, for a non-interest bearing demand note in the amount of $100,000, following which ACo would be wound up into BCo, which would then repay the $100,000 note payable to the estate after which BCo would be dissolved. The pipeline transactions were intended to result in the estate acquiring the $100,000 subject only to tax on the capital gain on the ACo shares in the hands of the deceased taxpayer, as opposed to the estate receiving and being taxable upon a $99,900 deemed dividend if capital loss carryback planning had instead been undertaken pursuant to a simple winding up of ACo into the estate pursuant to subsection 88(2) This example assumes that the $1,000,000 ACB to the estate is hard ACB for purposes of section 84.1 (i.e., generally ACB not derived from pre-1972 gains or through the use of the capital gains exemption (subsection 84.1(2))). Instead of a promissory note, Holdco could issue redeemable, retractable preferred shares with a redemption amount and stated capital of $1,000,000. Alternatively, instead of a tax-deferred winding-up undertaken pursuant to subsection 88(1), an amalgamation (e.g., a short-form vertical amalgamation) under section 87 could be undertaken. CRA Document No C6, dated October 9, Simplified, if ACo were wound up into the estate, assuming that the shares of ACo had a paid-up capital for purposes of the Act of $100, subsection 84(3) would deem the estate to have received a dividend of $99,900 (i.e., the $100,000 paid less the $100 paid-up capital). This deemed dividend would be excluded from the estate s proceeds of disposition pursuant to the provisions of section 54 and, accordingly, the estate would have a capital loss of $99,900 given its $100,000 ACB. Provided that this capital loss was triggered in the estate s first 5

6 In declining to comment on the possible application of subsection 84(2) in this example, the CRA noted that the provision requires that funds or property of a particular corporation must have been distributed or otherwise appropriated, in any manner whatever to or for the benefit of the shareholders on the winding-up, discontinuance or reorganization of the business of the particular corporation (i.e., ACo) (in which case a deemed dividend would result to the extent that the redemption proceeds exceeded the paid-up capital of the shares). The CRA noted that while it had ruled favourable previously in prior advance rulings on the nonapplication of subsection 84(2) (in addition to ruling favourably on section 84.1 and the general anti-avoidance rule in subsection 245(2) ( GAAR )), 16 in the ruling applications referred to the proposed transactions indicated that: the corporation in question (e.g., the equivalent of ACo in the example set out above in the paper) would remain a separate and distinct entity for at least one year (i.e., that it would not be wound up into or amalgamated with another corporation); during this period, the corporation would continue to carry on its business in the same manner as before; and only thereafter would the note be repaid, on a progressive basis. The CRA indicated that in these circumstances it was reasonable to conclude that the conditions for the application of subsection 84(2) had not all been satisfied. While the CRA declined to comment on the application of subsection 84(2) in the example considered, from the perspective of tax planners, perhaps somewhat hopefully the CRA noted that the three conditions summarized above that had been referred to in the favourable rulings were facts submitted by the taxpayers in question and could not be considered CRA requirements. 17 While the CRA s position remained uncertain following this round table discussion, the discussion placed tax practitioners on notice that the CRA might take the position that subsection 84(2) could give rise to a deemed dividend in a pretty typical pipeline plan. The CRA, however, continued to issue favourable rulings in circumstances in which the proposed transactions were generally similar to those that it had previously ruled favourably on. 18 More importantly, in a withdrawn ruling request in respect of a proposed post-mortem pipeline plan involving a holdco that was inactive and owned only liquid assets (which assets were possibly only cash), the CRA took the position that the holdco s surplus would be subject to taxation year, subsection 164(6) would generally permit the executor or executrix to elect to have the capital loss treated as a capital loss of the deceased in his or her terminal year rather than a capital loss of the estate. This capital loss could then be used to offset the capital gain arising in the deceased s terminal year by reason of the deemed disposition on death. CRA Document Nos , dated November 13, 2002, and R3, dated November 2, The CRA had previously explained these rulings in a similar manner in a technical interpretation (CRA Document No E5, dated June 29, 2006). See, for example, CRA Document Nos R3, from 2010, and R3, from

7 dividend treatment in the hands of the estate (although the CRA noted that capital loss carryback planning could be undertaken to avoid double taxation). 19 The CRA revisited this issue at the CRA Round Table at the 2010 Canadian Tax Foundation s Annual Conference. While the PowerPoint questions and responses distributed by the CRA were not definitive, in the discussions the CRA seemed to suggest that subsection 84(2) would be applied to a post-mortem pipeline of a corporation that held all cash. Provisions and Scheme of the Act Relevant to Pipelines In considering whether a deemed dividend may arise on a pipeline transaction in the example set out above, the relevant provisions to consider, in addition to GAAR, are subsection 84(2), section 84.1 and paragraph 88(1)(d.1). Simplified, subsection 84(2) provides for a deemed dividend on the winding up of a corporation in an amount equal to the FMV of the funds or property distributed to or for the benefit of the shareholders less the amount of the paid-up capital in respect of the shares in circumstances in which: funds or property of a corporation resident in Canada have been distributed or appropriated in any manner whatever to or for the benefit of the shareholders of any class on the winding-up, discontinuance of reorganization of its business Section 84.1 is also relevant in respect of the pipeline transaction contemplated in the pipeline example set out above. Section 84.1 applies in respect of surplus stripping transactions involving the transfer of shares of one corporation to another in circumstances in which the FMV of non-share consideration and the increase in the paid-up capital of the shares of the purchaser corporation exceed the greater of the ACB (as adjusted for purposes of section 84.1 (the ACB as so adjusted, the Hard ACB )) and the paid-up capital of the shares of the transferee corporation transferred to the purchaser corporation. Accordingly, the language and clear policy of section 84.1 permit such transactions, provided that the aggregate of the FMV of non-share consideration and of the increase in paid-up capital of the shares of the purchaser corporation does not exceed the Hard ACB of the shares of the transferee corporation. For purposes of section 84.1, ACB is generally reduced in respect of both pre-1972 gains and capital gains exemptions claimed on the share (or a share for which the share was substituted) of the taxpayer or a person with whom the taxpayer did not deal at arm s length. Accordingly, in the pipeline transaction contemplated in the example, provided that pre-1972 gains and capital gains exemption claims are not in issue, section 84.1 would appear to be intended to permit the form of surplus stripping contemplated (where the estate has Hard ACB by reason of the deemed disposition on death). Subsection 88(1) governs the winding-up of XCo into Holdco in the example contemplated. On such a wind-up, paragraph 88(1)(d.1) provides that subsection 84(2) does not apply to the winding-up of the subsidiary. In light of the above provisions, the CRA s position that subsection 84(2) may apply in respect of a basic pipeline appears to be doubtful in the example contemplated for the following reasons: 19 CRA Document No R3, from

8 Subsection 84(2) is expressly made inapplicable to the winding-up of XCo into Holdco by reason of paragraph 88(1)(d.1). On its face subsection 84(2) applies to distributions or appropriations to or for the benefit of the shareholders on the winding-up of XCo. On the winding-up of XCo, its sole shareholder is Holdco (and subsection 84(2) would not apply to deem there to be a dividend triggered on the winding-up of Holdco into the estate to the extent that $100,000 is paid on the note rather than on the Holdco shares). 20 The provisions of section 84.1, governing transactions of the type contemplated in the pipeline planning, permit the extraction of Hard ACB such as that of the estate. Where the Act has deemed there to be a disposition at FMV by reason of a taxpayer s death, particularly given the provisions of section 84.1, in our view, at least in the ordinary course, the estate should not be regarded as an accommodation party that has been inappropriately used to extract corporate assets, such that GAAR should not normally be engaged. Further, subsection 84(2) can apply only where assets have been distributed or appropriated on the winding-up, discontinuance or reorganization of [XCo s] business. Accordingly, where XCo is not carrying on a business (and, if it was formerly carrying on a business, where the distribution does not occur on the winding-up, discontinuance or reorganization of that business), subsection 84(2) should not apply in any case. 21 In suggesting that subsection 84(2) may be engaged in a typical pipeline transaction, the authors respectfully suggest that the CRA may in effect be seeking to tax an estate based upon a transaction that the estate might have undertaken rather than the transaction actually undertaken. Clearly subsection 84(2) should not apply to deem the estate to have received a dividend in the example set out and, it is suggested, GAAR should also generally not be engaged in light of the provisions of section 84.1 and the circumstances in which the estate acquired its Hard ACB. Practical Advice Regarding Pipelines in Light of CRA s Position While the authors are of the view that in the normal course the CRA s position is not wellfounded that subsection 84(2) may apply to deem the estate to have received a deemed dividend in a typical pipeline transaction, they note as follows: As far as the authors are aware, at least thus far CRA has not generally sought to take this position in dealing with a corporation that owns assets other than cash or near-cash It is acknowledged that some jurisprudence has taken a broad view of this aspect of subsection 84(2) (see, for example, RMM Canadian Enterprises Inc. et al v. The Queen, 97 DTC 302 (TCC), but see also Collins & Aikman Products Co. et al v. The Queen, 2009 DTC 1179 (TCC), affirmed 2010 DTC 5164 (FCA)). Some commentators have also suggested that even if the CRA were correct that subsection 84(2) could otherwise apply on a pipeline, as the deemed dividend would be inconsistent with the treatment accorded by section 84.1, the more specific wording of section 84.1 should govern. See, for example, Manu Kakkar and Nick Moraitis, Post Mortem Planning: Does the Pipeline Work? (2011) vol. 11, no. 1 Tax for the Owner Manager, 6-7, and Stuart Bellefer, CCH Estate Planner Newsletter 199, August 2011, Summary of the CRA Round Table Held at the 13 th National STEP Canada Conference,

9 In many cases, where the deceased did not wholly-own the corporation (e.g., where a prior estate freeze had been undertaken), it may be possible to implement a pipeline without it being necessary to wind up, discontinue or reorganize any business carried on by the corporation. To avoid the audit risk, where viable in implementing a pipeline, it is preferable to fall within the circumstances in which the CRA has previously ruled favourably (e.g., keeping the corporation in existence as a separate entity for at least a year and having it continue its business, and only thereafter repaying the promissory note progressively over time). However, even where this is not viable, it is suggested that it will often be helpful for planners to structure pipeline transactions such that they include a subsection 88(1) wind-up so that subsection 84(2) is expressly stated not to apply on the wind-up. 22 Recent commentary suggests that in appropriate cases it may be helpful to complete the transactions within the estate s first taxation year so that subsection 164(6) capital loss carryback planning may be available as a fallback option. 23 SECTION 159 CLEARANCE CERTIFICATES Rationale for Clearance Certificate Discussion Based upon the authors recent experience, there appears to be some uncertainty in the tax community as to the requirements of section 159, including what may constitute a distribution for purposes of the clearance certificate requirements, the circumstances in which liability may result and the protections afforded where a clearance certificate has been obtained. This uncertainty, combined with both the virtual impossibility referred to previously of complying with subsection 159(2) given the CRA s position that it will not normally issue a clearance certificate until after a taxpayer s final return has been filed and assessed, 24 and the tax community s consequential reliance on administrative practice, suggests that a review of the clearance certificate provisions in section 159 and of the CRA s administrative positions in respect of those provisions should be useful. This is particularly the case given that recent jurisprudence and a recent technical interpretation, discussed below, may suggest that the CRA may be quite aggressive in seeking to impose personal liability against legal representatives under subsection 159(3). Further, while it is unclear, another recent technical interpretation may suggest that the CRA believes that it can assess a legal representative under subsection 159(3) even where the underlying taxpayer s taxation year is statute-barred Paragraph 88(1)(d.1). In this case, the issue should then focus on GAAR; whether there has been a misuse or abuse for purposes of section 245 notwithstanding: (i) the deemed disposition on death; (ii) the provisions of section 84.1; and (iii) that the estate should not normally be regarded as an accommodation party in facilitating a surplus strip. Stuart Bellefer, CCH Estate Planner Newsletter 199, August 2011, Summary of the CRA Round Table Held at the 13 th National STEP Canada Conference, 4-6 (which notes that it would generally be necessary to late-file the subsection 164(6) designation, which would require that a fairness request be brought by the taxpayer pursuant to subsection 220(3.2) and Income Tax Regulation 600(b)). See above under the heading Introduction Section 159 Clearance Certificates. 9

10 Section 159 Overview Pursuant to subsection 159(1), a taxpayer s legal representative is made jointly and severally liable with the taxpayer to pay amounts payable by the taxpayer under the Act to the extent that the legal representative had possession or control of the taxpayer s property. A legal representative is defined broadly as: a trustee in bankruptcy, an assignee, a liquidator, a curator, a receiver of any kind, a trustee, an heir, an administrator, an executor, a liquidator of a succession, a committee, or any other like person, administering, winding up, controlling or otherwise dealing in a representative or fiduciary capacity with the property that belongs or belonged to, or that is or was held for the benefit of, the taxpayer or the taxpayer's estate. 25 Subsection 159(2) provides that a taxpayer s legal representative (other than a trustee in bankruptcy) is required, before distributing property in his or her possession or control as legal representative, to obtain from the Minister a certificate certifying generally that all amounts for which the taxpayer is liable under the Act, or can reasonably be expected to become liable, have been paid (or security provided therefore). 26 Where a legal representative (other than a trustee in bankruptcy) distributes property in his or her possession or control without obtaining a clearance certificate, subsection 159(3) makes the legal representative personally liable for the payment of all amounts referred to in subsection 159(2) up to the value of the property distributed. Subsection 159(3) also empowers the Minister to assess the legal representative at any time in respect of an amount payable pursuant to subsection 159(3). 27 Section 159 What s New? Possible Assessment of Statute-Barred Years As noted previously, a recent technical interpretation issued by the CRA, although its meaning is somewhat unclear, may suggest that the CRA believes that it can assess a legal representative under subsection 159(3) even where the underlying taxpayer s taxation year is statute-barred. 28 This technical interpretation has caused concern amongst tax practitioners as it appears to be internally inconsistent and may be contrary to long-standing jurisprudence and prior CRA interpretations. Although the summary of the interpretation states that an assessment under subsection 159(3) would not enable the Minister to reassess a statute-barred year, the reasons that are summarized and the body of the interpretation appear to suggest a contrary response Subsection 248(1). Subsection 159(3.1) provides generally that an appropriation by a legal representative of property in the possession or control of the legal representative in that capacity is deemed to be a distribution for purposes of subsections 159(2) and (3). While confirmation would not seem to be required, in CRA Document No , dated November 23, 1999, the CRA confirmed that a trustee in bankruptcy was not subject to subsection 159(2) and (3). The CRA also indicated that it would not issue a clearance certificate to a trustee in bankruptcy on the basis that it would serve no purpose, a position that the CRA also takes in its CRA Audit Manual, Chapter 16. CRA Document No E5, dated May 26,

11 In this regard, the reasons and the body of the technical interpretation state as follows: Reasons: The purpose of an assessment under subsection 159(3) is to enable collection of an amount owed by an estate. Furthermore, the legal representative is a person separate from the estate and an assessment under subsection 159(3) is not tied to the normal reassessment for assessing an estate. Body of Technical Interpretation: This is in reply to your inquiry as to whether the liability under subsection 159(3) would enable the Minister to reassess a statute-barred taxation year of the estate of a deceased taxpayer. The Minister may, pursuant to subsection 159(3), assess a legal representative at any time. The purpose of such an assessment is to facilitate collection of an amount owed by an estate, when a legal representative distributes property under his or her control without first obtaining a clearance certificate or posting acceptable security. The legal representative is a separate person from the estate and the timing of an assessment under subsection 159(3) is not tied to the normal reassessment period for assessing an estate. Moreover, neither subsection 152(4) nor the normal reassessment period defined in subsection 152(3.1) applies to an initial assessment under subsection 159(3). As noted above, subsection 159(3) does permit an assessment to be issued against a taxpayer s legal representative at any time. Accordingly, the comments made by the CRA in the reasons and the body of the Technical Interpretation, read in isolation, may well be accurate. However, in response to the question of whether subsection 159(3) would enable the Minister to reassess a statute-barred year of the underlying estate, the comments appear to be superfluous unless they are meant to suggest that the Minister could thereby reassess in respect of the estate s statute-barred year. If the response is intended to take this position: The result would appear to be counterintuitive given that the liability under subsection 159(3) is solely derivative. Although the Act provides that a taxpayer s liability is not affected by the fact that no assessment has been made, 29 if the Minister is statutorily precluded from assessing the underlying taxpayer it is suggested that much clearer language would be required to permit a third-party such as a taxpayer s legal representative to be assessed in respect of that same liability. In this regard, it is submitted that the better reading of the at any time language of subsection 159(3) is to permit an assessment of a legal representative in respect of a taxpayer s liability, even if the taxpayer could no longer be assessed, provided that the underlying liability is not at that time statute-barred (e.g., where the underlying taxpayer had been assessed within the time limited by the Act or where that time had not then expired). 29 Subsection 152(3). 11

12 As discussed below, 30 the CRA has previously agreed that subsection 159(3) could not be used to assess a legal representative where the underlying taxpayer s taxation year was statute-barred. This conclusion has also been reached in relevant jurisprudence. 31 Further, as is also discussed below, in an even more recent technical interpretation, the CRA seems to accept that an assessment of a legal representative, where the underlying taxpayer had not been assessed (and had been dissolved), must be made within the limitation period applicable in respect of the underlying taxpayer. 32 Inability to Retain and Pay Professional Advisor Without Risking Subsection 159(3) Assessment Another recent technical interpretation represents a particularly harsh and perhaps surprising interpretation of the requirements of subsections 159(2) and (3). 33 The interpretation related to a deceased taxpayer who had failed to file tax returns in the years prior to his death. Following the taxpayer s death, very substantial assessments were raised which gave rise to a liability substantially in excess of the estate s assets. The deceased s father, who was the legal representative of the deceased, disagreed with the amount of the assessments and wished to use the estate assets to retain the services of an accountant to prepare the tax returns that the deceased had not filed. In respect of this matter, the CRA stated as follows: an estate is first required to pay any tax liability before assets can be distributed. However, allowance can be made for the payment of reasonable funeral, testamentary, and administration costs. The size of the tax liability, the extent of assets in the estate, and the disinclination of the deceased to comply with the Act, are factors, which are not conducive to agreement to allow estate assets to be used to dispute the assessments. At the very least the decision to dispute the assessments should be made objectively, which rules out anyone who stands to profit or gain from the outcome. Accordingly, the estate has three options: the estate could make an assignment into bankruptcy; 34 the administrator could personally fund the services of an accountant; or the administrator could use estate assets to fund services of an accountant, but would do so at the risk of being held liable under subsection 159(3). Needless to say, there are pros and cons associated with each of the options. should the administrator decide to pay for the services of an accountant out of the assets of the estate without first obtaining a clearance certificate, he would be at risk of being assessed under subsection 159(3) See below under the heading Failure to Obtain a Clearance Certificate Personal Liability of Legal Representative, Where Underlying Liability Statute-Barred. The Queen v. Wesbrook Management Ltd., 96 DTC 6590 (FCA). CRA Document No I7, dated August 10, CRA Document No E5, dated March 14, In respect of the bankruptcy option, which can of course be quite expensive, it is noted that subsections 159(2) and (3) do not apply to a trustee in bankruptcy. 12

13 The position taken by the CRA presupposes, consistent with a long-standing position of the CRA, that distributions for purposes of subsection 159(2) include payments made to creditors, a position that is commented upon below. 35 Interestingly, and more positively, the interpretation goes on to confirm that should the father ultimately be assessed as legal representative: It would be open to the administrator to challenge the underlying assessment, see Abrametz v. The Queen, [2009] G.S.T.C. 43, 2009 GTC 2013 (F.C.A.); and Gaucher v. The Queen, [2001] 1 C.T.C. 125, 2000 DTC 6678 (F.C.A.). (italics added) The authors suggest this is the better interpretation (i.e., that the legal representative under subsection 159(3) can challenge the underlying assessment where it was challenged not by or on behalf of the taxpayer). However, this issue has been considered not to be fully resolved in the case of subsection 159(3) where the legal representative may have had the ability, albeit qua legal representative, to challenge the initial assessment. 36 Accordingly, this confirmation from the CRA is welcome. CRA Assessing Under Subsection 159(3) Where Funds Deposited in Estate Account Inadvertently A recent decision of the Tax Court of Canada, Nguyen et al v. The Queen, 37 may serve to illustrate how aggressively the CRA may seek to impose personal liability on a taxpayer s legal representatives where clearance certificates were not obtained. In this case, Mr. Hien Vohoang had died unexpectedly in 1993, leaving a wife and three children. Mr. Vohoang died intestate and with an estate that was in a very substantial deficit, including in respect of income taxes. The assets of the estate had been seized by creditors. Mr. Vohoang had held some life insurance policies, however, in which his wife and/or three children were the designated beneficiaries (such that the proceeds from the policies would not flow through the estate, where they would have become available to creditors including the CRA). Through inadvertence, some of the insurance proceeds were deposited into an estate bank account. The funds were ultimately paid out to Mr. Vohoang s widow, Ms. Nguyen, and the three children. Virtually ten years later, in 2003, the Minister assessed Ms. Nguyen and the oldest of the three children on the basis that they were legal representatives who were personally liable in respect of payment from the estate as they had failed to comply with subsection 159(2). The Minister also issued assessments under section 160. Based upon these facts, Angers J. concluded that the insurance proceeds that had been deposited into the estate bank account had never formed part of the estate. Accordingly, Angers J. found in favour of the taxpayers and allowed the appeal See below under the heading Whether a Particular Transfer is a Distribution?, Payment to Unsecured Creditors. This issue is commented upon below under the heading Failure to Obtain a Clearance Certificate Personal Liability of Legal Representative, Ability to Challenge Underlying Liability. Nguyen v. The Queen, 2011 DTC 1059 (TCC). 13

14 It is possible that the Minister may have assessed under subsection 159(3) given uncertainty as to the facts. However, the case does illustrate how broadly the CRA may seek to apply the personal liability provision. The fact that the assessment under subsection 159(3) occurred so long after the relevant events also illustrates the dangers that a legal representative may face under subsection 159(3) given that the Minister is authorized to assess at any time. Subsection 159(2) Mandatory Additional Potential Exposure to Legal Representatives The provisions of subsection 159(2) are mandatory. Accordingly, the failure of a legal representative to obtain a clearance certificate prior to making a distribution would expose the legal representative not only to personal liability pursuant to subsection 159(3) but could result in the legal representative being subject to penalties under paragraph 162(7)(b) and, in particularly egregious cases, possible charges of wilfully evading compliance with the Act. 38 Accordingly, while the CRA confirmed many years ago that it would not normally consider proceeding under paragraphs 162(7)(b) or 239(1)(d) in respect of the failure of a legal representative to comply with subsection 159(2), 39 this additional potential exposure illustrates how critical it is for a legal representative to take into account his or her obligations under section 159 prior to making distributions. 40 Whether a Particular Transfer is a Distribution? The clearance certificate requirements in subsection 159(2) and the personal liability provisions of subsection 159(3) will not be engaged unless the taxpayer s legal representative makes a distribution. Subsection 159(3.1) generally deems an appropriation by a taxpayer s legal representative of property in the possession or control of the legal representative acting in that capacity to be a distribution. Apart from that narrow deeming provision, the Act does not specify what constitutes a distribution for purposes of subsections 159(2) and (3). Given that there is little relevant jurisprudence on this issue, the CRA s various comments as to what it considers to constitute a distribution for purposes of section 159 are of considerable interest. In this regard: Payment to Secured Creditors The CRA has long accepted that, at least administratively, payment by a taxpayer s legal representative to a secured creditor in payment of a properly secured debt is not a distribution to which the provisions of subsections 159(2) and (3) apply. In this regard, the CRA has stated as follows: Paragraph 239(1)(d). CRA Document No. October , dated October The CRA confirms in Information Circular 82-6R8, Clearance Certificates its view that a legal representative does not need to obtain a clearance certificate before each distribution so long as he or she keeps enough property to pay any liability due to the CRA (para. 2). This position does provide some administrative comfort in respect of possible exposure under paragraphs 162(7)(b) or 239(1)(d). However, it is generally of no assistance in respect of personal liability of the legal representative if it turns out that sufficient property was not retained (e.g., if there is a shortfall due to an unanticipated reassessment). 14

15 The Department s administrative position is that where a responsible representative (as described in subsection 159(2)) turns over the proceeds of realization to a secured creditor subject to a valid security instrument such payment is not considered to be a distribution for the purposes of subsection 159(2). the sale or other disposal of a specific property to satisfy a debt secured by that property is also not considered a distribution. 41 The CRA has explained this position by stating as follows: Our policy of not considering payments to secured creditors (as long as the payment does not exceed the amount of the secured debt) as distributions under subsection 159(2) is based on the rationale that it would be unreasonable to insist on a clearance certificate before distribution of funds on which Revenue Canada would not have an enforceable claim. 42 Payment to Unsecured Creditors It has been the CRA s long-standing position that the payment to an unsecured creditor by a taxpayer s legal representative represents a distribution to which subsections 159(2) and (3) are applicable. For example, in a technical interpretation, the CRA, after confirming that administratively the CRA considers that payments to secured creditors are not treated as distributions under subsection 159(2), states that: In the event that distributions to secured creditors involved assets that are not subject to a valid security instrument (i.e., post-receivership operating profits not subject to a floating charge ), we agree that subsection 159(2) should apply. 43 Further, in the very recent technical interpretation discussed above, the CRA takes the position very clearly that payments to unsecured creditors constitute distributions under subsection 159(2), stating that an administrator might be assessed under subsection 159(3) if an accountant were retained and paid from assets of the estate to prepare tax returns of the deceased with a view to challenging assessments issued by the CRA. 44 The CRA does state in this technical interpretation, however, that at least in the context of an estate, allowance can be made for the payment of reasonable funeral, testamentary, and administration costs CRA Document No. rrrr293, dated May 18, CRA Document No. ACC9203, dated March 28, While less explicit, the CRA s comments in CRA Document No E5, dated January 29, 2010, appear consistent with this position. Further, relatively recent informal discussions between the authors and the CRA s Rulings Directorate suggest that the CRA continues to maintain this position in respect of secured debt. CRA Document No. ACC9203, dated March 28, See also CRA Document No , dated October 25, 1989, in which the CRA indicated that a subsection 159(2) distribution would seem to entail a pro rata distribution to one or more creditors. In CRA Document No. November , dated November 1990, however, the CRA agreed that payments on account of a debt would not be considered distributions for purposes of subsections 159(2) and (3). CRA Document No E5, dated March 14, 2011; see the discussion of this interpretation, above, under the heading, Section 159 What s New, Inability to Retain and Pay Professional Advisor Without Risking Subsection 159(3) Assessment. See also CRA Document No E5, dated January 29,

16 Whether a payment constitutes a distribution would typically depend upon the context in which the term is used. In the context of subsections 159(2) and (3), although more detailed consideration would be required, in the view of the authors it is not self-evident that the CRA is correct that a distribution necessarily includes payment of a liability owed to a creditor. 45 For example, in dealing with a voluntary dissolution or winding up of a corporation, both the Business Corporations Act (British Columbia) (the BCBCA ) and the Canada Business Corporations Act (the CBCA ) generally contemplate that the corporation will pay, satisfy or compromise, and discharge or make provision for its liabilities and, thereafter make distributions to its shareholders. 46 Accordingly, practitioners may wish to revisit this issue in dealing with assessments issued under subsection 159(3) in respect of payments to creditors. However, from a planning perspective, in light of the position taken by the CRA, a taxpayer s legal representatives need to be careful in paying even unsecured arm s length creditors of a taxpayer where there may ultimately be an inability to pay the taxpayer s income taxes owing. Payment of Income to Trust Beneficiaries The CRA has confirmed that payments of the income from a trust or estate to a beneficiary are not considered to be distributions, such that a clearance certificate is not required. 47 Transfer to a Replacement Executor or Trustee The CRA has confirmed that the transfer of estate property from an executor to a replacement executor does not result in a distribution. 48 Distribution by a Legal Representative Corporate Director Given that the definition of legal representative 49 does not include a corporate director, it has long been debated whether or not a director may nonetheless be included as an other like person in the context of a winding-up. The CRA takes the position that a director is a legal representative on the voluntary dissolution of a corporation where there is no formally appointed liquidator and where the relevant responsibilities are assumed by the director. In this regard, the CRA states as follows: In this regard, the authors note that there is jurisprudence suggesting that the clearance certificate provisions should be construed strictly given that the provisions are penal in nature (Taylor v. MNR, 86 DTC 1232 (TCC) and MNR v. Parsons, 83 DTC 5329 (FCTD)). See, for example, sections 210 and 211 of the CBCA and sections 325, 330 and 336 of the BCBCA (although there is at least one reference, in section 330(h) of the BCBCA, to monies held by a liquidator required for distribution to creditors and shareholders, thus illustrating, in the view of the authors, that the term can derive its meaning partly from its context). Information Circular 82-6R8, Clearance Certificates, December 10, 2010, para. 15, and CRA Audit Manual, Chapter 16. CRA Document No , dated An advance ruling referred to in a recent article may also have taken a similar position (Greg Boehmer, Kathleen Hanly, and Eric Xiao, "Insolvency: Selected Income Tax Issues Relating to Debt Restructuring and Liquidation," Report of Proceedings of Sixty-First Tax Conference, 2009 Tax Conference (Toronto: Canadian Tax Foundation, 2010), 7:1-36, at 34-35). Subsection 248(1). 16