In this article, I will discuss three recent developments that I believe will be of interest to readers.  One of these is well known, the other two, less so.

Just about everyone knows of the appointment of Marshall Rothstein to the Supreme Court of Canada, the reason, of course, being his 3½ hour TV show that turned out to be more of a meet ‘n greet than US-style grilling. 

Of course, tax practitioners need no introduction to Justice Rothstein, as he has been involved in scores of tax cases over the years.  While he is most well-known for the OSFC GAAR case[1] (which, in essence, went to the Supreme Court in its incarnation as Kaulius et al), Justice Rothstein has penned quite a number of other high-profile -known decisions.  These include Novapharm[2] (a pre-GAAR transfer of tax losses using interest deductions – the taxpayer lost); Silicon Graphics[3] (a restrictive interpretation of the de facto control test – the taxpayer won); Gifford[4] (in which Justice Rothstein respectfully submitted that - notwithstanding dusty old case law, interest deductions should be a current rather than capital expenditure - but was bound by precedent); Markevich[5] (which upheld a six-year limitation period on tax collection proceedings – the Income Tax Act was subsequently amended to lengthen the period); Singleton[6] (which involved a lawyer who did a “capital rollaround” to deduct his interest – the taxpayer won); and Stewart[7] (which involved the reasonable expectation of profit test – the taxpayer lost[8).

It can be expected that Justice Rothstein will pen most of the tax cases coming up to the top court, as was the case with his tax-minded predecessor, Justice Iacobucci.  While I think it is fair to say that Justice Iacobucci’s decisions have a distinctly taxpayer-friendly tone, based on Justice Rothstein’s track record in the Federal Court, he can be expected to be more down the middle.  But there is no denying the quality of Justice Rothstein’s tax decisions (the Supreme Court has upheld a high percentage of his verdicts).  Personally, I think that his OSFC GAAR reasoning was pretty impressive.  It is ironic that, until such time as another Supreme Court GAAR case comes along, the law on GAAR will not be Rothstein’s OSFC, but the Canada Trustco/Kaulius Supreme Court verdicts – handed down during the hiatus between Iacobucci and Rothstein.  It will be good to have a “tax judge” back on the Supreme Court. 

Going Overboard on Directors’ Liability

Late last year, the Scavuzzo case, a decision of Tax Court Chief Justice Bowman, was released, featuring some ground-breaking observations on directors’ liability.  The first issue canvassed by the case is whether, in the course of defending against a director’s liability for withholding and the like, the director can challenge the merits of the underlying corporate assessment.  Although this has been canvassed in other areas[9], earlier tax court cases in respect of directors’ liability had split on this issue.  Happily, Justice Bowman added to the tally in favour of the good guys, holding that directors can do so.

The other main issue of the case is that the CRA had assessed Jack Scavuzzo as a director, even though he had submitted his resignation more than two years before he was assessed, on the grounds that he was a de facto director and therefore liable.  Happily, the court held that after the taxpayer had resigned, he never held himself out as a director, nor did he exercise the sort of control over the corporation’s affairs that one would expect of a director.[10] 

What I find particularly troublesome is that the CRA seemed to be hell bent on proceeding against Mr. Scavuzzo, notwithstanding his resignation – i.e., on the de facto director grounds.  When section 227.1 was originally enacted, the government assured tax practitioners that this section was to be used sparingly.  The lengths to which the CRA was willing to go in this case were also disturbing to Justice Bowman, and attracted some blistering comments toward the end of the case, observing among other things, that the CRA had continued its attack when Mr. Scavuzzo was diagnosed with cancer, and had assessed another employee, forcing her into bankruptcy, before CRA officials came to the view that the assessment was wrong.  Justice Bowman summarized the CRA’s conduct as “reminiscent of Sir Ronald in Stephen Leacock's story Gertrude the Governess, who ‘flung himself upon his horse and rode madly off in all directions.’”  That’s not how I’d put it.

Of course, this is simply another manifestation of what can happen when the CRA or other government officials are given wide-ranging powers, be they in respect of the enforcement of directors’ liability, GAAR and other broadly-worded anti-avoidance provisions - or just giving out speeding tickets.  I contend that paid government officials cannot be trusted to use such provisions sparingly – they are, after all, biased.  That’s why there is a need for procedural safeguards; and why tax practitioners and their professional associations need to be continually vigilant.[11]

Non-Disruptive Professional Incorporation

The final thing I would like to talk about in this article are two favourable tax rulings which will facilitate the formation of professional corporations by partners to receive part of their would-be partnership income. 

In essence, the rulings[12] sanction a partner’s professional corporation receiving fees from the partnership for enumerated services, while the individual in question remains a partner in the firm, subject to profit sharing for the remaining income.  While some earlier rulings envision the incorporation of the firm itself, accompanied by “satellite” professional corporations, the more recent rulings support a structure that is both flexible and “non-disruptive” to the continuation of existing firms.

To the extent that a partner can retain income for reinvestment in his or her corporation (i.e., without the necessity of distributing it to defray personal living expenses), the advantages of a professional corporation are significant: in Ontario, for example, the applicable tax rate for a corporation qualifying for both the federal and provincial small business deduction is less than 19%, whereas the top personal rate is in excess of 46%.  If a professional corporation were to earn and retain $300,000 (currently the maximum federal small business limit), the annual deferral would exceed $80,000 per year.