lsa.mcgill.calsa.mcgill.ca/pubdocs/files/taxation/643-christians_taxat…  · Web viewto day, approx. 60% of tax revenue comes from personal income & national-level consumption taxation.

TaxationPUB2-313

Prof. Allison ChristiansFall 2015

1. Foundations Tax as a mean for government to pay for services and provide goods to the population;

philosophers of the social K – Locke: implied covenant that in exchange for providing goods, elected leaders can ask for the contribution of the people; Hobbes: to secure our life, we agreed to constrain ourselves and taxation is a way through which government can insure safety of the people.

Other possibilities: public debt; revenue from state-owned enterprises; direct seizure. Questions that will be analyzed: who, what, when and how should we tax?

1.1. The power to tax Ruling contravenes w/ individual rights, by extracting resources/constraining individuals for

common projects; constitutional and international protection against interference w/ private property; how is taxing consistent with these protections?

o Sovereignty: states may tax b/c of their sovereign status (maintaining itself & providing public goods) demands it;

Difficulty: Hobbes’ argument is based on an account of sovereignty that is inconsistent w/ democracy/ at least a defense of equal right to dignity and to unarbitrary protection of inalienable rights – e.g. bloodline ruling class, right to tax anyone, etc.

o Jean Bodin: levying tax and exempting persons from payment is part of making law and granting privileges; taxation is not inseparable from the essence of statehood.

But why is taxation a special right that only belongs to the state?o State has a right to tax b/c it contributes to economic outcomes by providing the

laws, institutions, and mechanisms necessary to enable market transaction;

I’m not sure to see the point: but for the right to tax, there would be no antecedent foundation of private property and therefore no possibility of individual wealth?

Bottom-line, there is a lasting justification problem w/ legitimacy of the states to tax, even w/ social K theories. That is why nations generally assert their authority to levy taxes through Constitutions.

o Canada: Fed has power to impose taxes of any kind; provinces may impose direct taxation; see s. 53, 54, 91, 92, 125 (no mention of “right to tax”) – similar in the U.S. but ø European Convention of Human Rights.

Conclusion: states tax w/ implied consent of people, which means that this right is not absolute (needs to be in accordance w/ the will of the people). Therefore, if the taxation exercise amounts to unfairness, it might be rebuttable.

1.2. The evolving tax consensusIndirect taxes: taxes on trade, tariffs or excise (taxes on goods); direct taxes: personal income taxation. In the inter-war period, shift from trade to income tax.

Income Tax Act of 1917 ( ITA ) – small % would pay income taxes (low rates & high exemption levels); to finance WWII, the federal tax system increased the share of income taxation (class to mass tax);

up to day, approx. 60% of tax revenue comes from personal income & national-level consumption taxation.

To compare taxation w/ other countries, economists may use revenue as a percentage of GDP; but imprecise because countries define revenue and report GDP differently. Canada generally relies more on personal income tax than other forms of taxation when compared w/ other countries; however, it collects about the same amount of tax revenue as a % of GDP as the OECD average.

1.3. The recursive cycle of tax lawmakingImplementation follows a different logic than creation of tax law.

2. Structure2.1. Who should we tax?What is the base that we tax?

2.1.1. HumansITAs.2

Charging provision (1) income tax on [taxable income], each taxation year, of every person resident, anytime;(2) taxable income of taxpayer = year’s income +/– deductions Div. C.

Question: what is a person & what is a taxpayer?

ITA s. 248

Definitions /person/ = any corp., entity exempted under s.149 & legal representatives of the P;/individual/ = person that = ø corporation;/taxpayer/ = any person whether or ø liable to pay tax.

Conclusion: s.2 purports to impose tax on humans & entities, but only if they are Canadian residents.

Canadian residents’ income is taxable whatever the sources; non-residents are taxable only on Canadian-source income. Rate is also a function of whether or not the taxpayer is a resident ( s. 2(3), 3, 117).

Comparison: Can. taxes all individuals/ US taxes based on marital-family status – taxable unit system (allowing income splitting);

ITAs.117

Tax payable (1)15% on the first $44,701 of taxable income, +22% on the next $44,700 of taxable income (on the portion of taxable income over $44,701 up to $89,401), + 26% on the next $49,185 of taxable income (on the portion of taxable income over $89,401 up to $138,586), + 29% of taxable income over $138,586.

s.117.1 Calculus for inflation adjustment

Question1/ $44,701 *15% = $6705.15$44,700 * 22% = $9824$10 599 * 26% = $2755.74Total = $19 294.82/ No family units so individual each pays the first rate: $44,701 * 15% = $6705.15$5299 * 22% = $1165,78

Total: $7870,93

2.1.2. EntitiesEntities separated from their owners for legal purposes (to have legal entitlements/obligations w/o bearing on the individual personally);

Def. /person/ = corporation, trust, other listed entities (partnerships, non-corporate forms of business).

A – PartnershipDef. /partnership/ = 2 or + people coming together to engage in an activity for purposes of making a profit; ≠ partnership of 1.

Problems: partnership often arises casually, w/o parties even realizing it (unless some problem comes along). Nevertheless, transactions occurring within this partnership have tax effects. Also, people may use legal relationship to alter the results from engaging in various activities (e.g. person creating a corporation and then engaging in a partnership w/ his wholly-owned corporation).

ITAs.96-103

Partnership 96/(1) If taxpayer is member of Pship, TP’s income, non-capital loss, net capital loss, etc. or TP’s can. taxable income is computed as if:(a) Pship = separate person(c) ea. Pship activity = carried on by Pship as separate person;(f) the amount of income of Pship for a source = income of the TP for that source to the extent of the TP’s share

Question4/It’s a Sunday in August in Montreal, and two kids decide to make some lemonade and bring it to Parc Mont Royal to take advantage of the tamtam crowd. Their parents help out by buying the supplies, overseeing production and set-up, and replenishing supplies over the course of the afternoon. It’s a hot day and the kids take in $3,000. At the end of the day, the parents reclaim their costs and put the rest of the money in college savings plans for the kids. Who earned what, for federal tax purposes?$3,000 – cost (loss or capital loss?) = taxable income of the parents (b/c kids have no share – only beneficiaries if it goes in a college saving plan)

B – CorporationsDef. /corporation/ = entity incorporated under fed/prov. Law as such. This means that all corp. involve intention/forms on the part of the forming parties.

CML: private (50/- shareholders & can’t offer shares to the public) & public (larger & + widely held) corporations; although distinction is not so clear-cut in ITA.

ITAs.89

Corporation (1) Def. /Can corp./ = currently resident in Can & either incorporated in Can or been resident since 1971; taxable unless

TrustPartnershipCorporation

exempted under Part 1.s.123 (1) Tax = 38% flat rate;

(2) Tax reduction (net fed. rate ≈ 15% or possibly lower for CCPCs)s.125 (7) Def. /Can controlled private corp. (CCPC)/ = private corp. that ≠

controlled by non-resident P or pub. corp.

Rules for computing income for corp. are in general the same as those for individuals (both are P & TP);

Who is really bearing the corporation tax? Corporations or individuals behind them? ITA can identify a corp. as a TP in a statute, but it cannot prevent the tax from being borne by individuals.

Report of the Royal Commission on Taxation While easy to administer & efficient as a revenue rising mean, is corporate tax efficient & equitable?Problem when tax is not integrated w/ taxation of incomes of individual shareholders as P: tax minimization.

- Possibly shifted to the consumers/suppliers through prices changes → crude sales/cost-factor taxes;

- Tax on wealth at the time they are imposed;Distortion of allocation of resources & reduction of value of national output;Equity & neutrality → no tax on organizations, but P holding interests taxed on accrued net gains from such interests;However → difficulty to tax accrued share gains; loss in economic benefit in Canada b/c non-resident holding shares in Can. Corp. would not be taxed by Canada.

Who bears the corporate tax? In assigning the corp. tax burden, no guidance is given by statutory incidence (b/c only individuals can bear the burden of taxation). Simplest theory of tax incidence: tax falls on corporate shareholders in proportion to their ownership. Complication:

- If corp. have different types of shares, each category of shares confer different rights to the corporation’s income, therefore complicating allocation in case of reduction of tax rate for e.g. Assignment of income is not always clear.

- Even if assignment of income is clear, not all shareholders are individuals.Therefore, we know very little about who bears the corporate tax, except for that the corp. itself does not. However, a gov. that fails to tax corporations would in effect be inviting its TP to engage in all kinds of efforts to hide income within the corporate form. On the other hand, the corporate form understood as a separate taxpayer creates troubles for gov., especially in a globalized world.

C – TrustDef. /trust/ = relationship among a grantor and trustee, who contract w/ ea. other in respect of beneficiaries of the property to be held in trust; it involves 3 parties.

ITAs.104

Trust (1)

Numerous types of trust. Two main types:

1- Tax free savings accounts (TFSAs): generally non-taxable (except when trust are used to carry on business/to acquire non-qualified investments);

2- Registered education savings plans (RESPs)

Question5/ No tax on the TFSA; parents b/c the child is the beneficiary (?)

2.2. What should we tax?2.2.1. Income

Individual income, corporate income & payroll taxes

A) Definition

Rethinking the concept of income in tax law and policy, DuffHaig/Simons definitions = touchstone for normative debates in North American tax law & policy. However, three major departure from these def in the US/Can. - exclusion of imputed income from leisure, services & durable goods; exclusion of gifts & inheritances; recognition of gains & losses when realized through a sale. Justification – necessary compromises from practical challenge of collecting tax.Haig – income as a flow of satisfactions; benefits/utility over a period of time through the spending of $ in the object of our desires. But only the satisfactions that derive from goods/services susceptible of evaluation in $ are of interest for tax purpose. Tax on the money-worth of the goods/services = consumption tax; income = increase in one's power to satisfy his wants in a given period (that power = $ or anything that can be translated in $). Therefore -- Haig def/income/ money-value of the net accretion to one's economic position btw 2 points of time;Simons – income tax aims at mitigating economic inequality by increasing gov't's revenues. Therefore, personal income should be conceived as "a purely acquisitive concept having to do w/ the possession & exercise of rights … not w/ sensations, services or goods" - stark contrast w/ Haig. Therefore, Simons def/income/ algebraic sum of (1) market value of rights exercised in consumption (what has been "destroyed"); & (2) change in the value of the store of property rights btw in a given period.

(What I acquired + Δ value of these objects of consumption?)

B) Statutory frameworkTAs.2

Income tax (1) Income tax paid on taxable income for ea. tax. year of ea. Can residents;(2) Taxable income = TP's income for the year + add/deductions in Division C.

To understand the income tax, we need to know what income means in the Canadian legislative scheme and what are the applicable additions and deductions.

Division B – net income for tax purposes; Division C – additions & deductions.

Four major types of income – each requires a net separate calculation.

2 other sources of net income: other sources of income & other deductions from income (see s. 56 ff. – pension income, spousal support, social assistance payments).

TAs.3

Taxable income (a) Income & deductions for ea. basket; gross income – applicable deductions from Part 1, Div. A, Sub. a–d; + amount = net income = 3a amount; - amount = net loss;

(b) Determine whether capital gains exceed c. loss; net capital loss = reportable to another year; net capital gain = 50% added to income (3b amount);

(c) (3A + 3B) + deductions authorized under Sub. e (s.60 ff.) (deductions on any source of income) = 3c amount;

(d) 3c amount – net loss (3a) = 3d amount; if + = net income; if - = no income.

C) CML frameworkIn Canada, income is defined according to its sources; in the U.S., gross income = all sources – which seems more inclusive. But both statutes include “not limited to” language, which opens the possibility to modify the interpretation through CML courts.

Bellingham v. The Queen, [1996] Federal Court of Canada – Appeal Fact: Taxpayer was 1 of a small group of landowners whose lands were expropriated. Under the Expropriation Act, the Board is under the obligation to award additional interest in circumstances where the expropriating authority offers less than the amount ultimately awarded and the Board is of the opinion that such lower figure was due to the fault of the expropriating authority. Board awarded $1M of AI.Question: 1/ Whether “proceeds of disposition” were received on account of income or capital? 2/ Whether a specific award of “additional interest” made under subsection 66(4) of the Expropriation Act constitutes “income”?Holding: 1/ income; 2/ no – windfall gain;Analysis:1. The property was acquired as a concern in the nature of the trade, therefore the profit is

Salary, wages, other remuneration, gratuities from carrying on employment - deductions from that activity;Only individuals;Loss is possible but unusual;

Net office/employment income/loss

Inclusions related to carrying on a business, - deductions from that activity;Individuals, corporations, trusts;Net business losses of individuals can sometimes be used to offset net employement income;

Net business income/loss

Inclusions related to the holding of property, - deductions related to holding such property;individuals, corp. & trusts;Includes interest received on debt, lease payments received on rental property;

Net property income/loss

Inclusions related to the sale of personal prop.;arise on dispositions by individuals, corp, trusts;only 50% of capital gains are included; 50% of captial losses are deductibles;Net allowable capital losses cannot be deducted against any other type of income;

Net capital gains income & loss

taxable on account of income and it is immaterial whether the property was disposed of by sale or expropriation.2. B argues that additional interest is an award in respect of punitive damages, not interest in the strict legal sense, & that additional interest (AI) is not compensation for lands & therefore doesn’t constitute parts of the proceeds of disposition. She further argues that even if AI is deemed part of the proceeds, than it should be treated as a capital receipt as the $377,015 compensation award (acc. to s. 54(h)(iv) TA).The flaw in B’s argument is that she assumes that the provision deems proceeds of disposition to be a capital receipt. However, s. 54(h)(iv) TA was added to counter a decision (Kicking Horse Forest Products) which held that expropriation did not constitute a sale and therefore could not yield proceeds. Therefore, it seems clear that the compensation award is taxable as income from a business (in a broad sense) under s. 9(1) TA. Whether AI falls under windfall gains in the meaning of s. 3(a) TA.Sani Sport v. The Queen (1987) – Compensation paid will be treated as a unitary sum for tax purpose, except for compensation paid for injurious affection.Shaw v. Canada (1993) – ordinary interest is compensation for loss of use of money not paid on the date of expropriation; while distinguished from the cost payment, they both have the same source (the expropriation). Mannik v. The Queen – Additional interest is not compensation for the land taken, nor for loss of use of money, but is penal by nature: intended to discourage unrealistic payments from being tendered.Fisher v. The Queen (1986) – Additional interest constitutes partial consideration in recognition of the taxpayer’s property interest. OVERTURNED by Shaw & Mannik.Def/income/: (narrow) – only amounts received by TP on a recurring basis; (broad) – all accretions of wealth. No def in TA except it has to come from a source.Source doctrine: income is circumscribed by its origin; TA – enumerated sources but opened the possibilities of non-listed sources. Historically, division btw receipt of income from a source and disposition of the source itself creates the distinction btw income and capital. Before 1984, ambiguities in taxing statute being penal in nature were to be resolved in favor of the TP. In 1984, Stubart Investment v. The Queen (1984) replaces this rule by interpretative method seeking to outline the context and purpose of the statute to solve ambiguities. Residual presumption (rather than strict) in favour of TP if this rule doesn’t solve the ambiguity. However, J. considers that this approach doesn’t get us really far when it comes to the source doctrine, b/c Parliament modifies sources of income for policy reasons, independently of the source doctrine (as historically set out – for e.g., capital is taxable to a certain extent). Exclusionary categories of s.3(a) TA:1. Gambling gains: b/c gains doesn’t flow from a productive source (source capable of producing income);2. Gift/inheritance: b/c non-recurring amounts & not creating new wealth;3. Windfall gains: payment which is unexpected & not of a recurring nature is more likely than not to be characterized as windfall gains.

- Some indicia set out in R v. Cranswick (1982): o TP has no enforceable claim to payment;o No organized effort to receive payment;o Not sought/solicited by TP;o No recurrence;o Payor isn’t customary source of income for TP;o Not earned in exchange of services & not paid in consideration for recognition of property;

In the case at bar:- No need to resort to the residual presumption;- While TP has an enforceable rights to additional interest once the Board concludes there

was fault on the part of the expropriating authority, the source of additional interest is not

in the expropriating authority;- The source is the Expropriation Act policy choices to deter certain reprehensible behavior

& is unrelated to the issue of fair compensation for the expropriated land; it doesn’t flow from an agreement btw the parties, there is no bargain or exchange, no consideration, no quid pro quo, and while TP has an enforceable right, she didn’t seek this payment, that is, sought or solicited the reprehensible conduct of the expropriating authority.

Potential counter-argument: AI nonetheless stems from the expropriation transaction & therefore, it should not be separated from the complex bundle of compensation arising from the Expropriation Act.

- Response: compensatory & non-compensatory (penal) receipt should be treated differently because of the source doctrine – we have to look at the specific source from where the receipt stems. To do so, one needs to assess the nature & purpose of a particular award to assess how to treat it for tax purpose. In other fields of law (XK & K), special damages are treated separately from compensation for fault or breach of contract.

NB: Court refuses to assess whether additional interest is a “non-recurring, unexpected, unusual form of income”.

Question 1: Does the assessment of “nature & purpose” of a particular award fall under the contextual & teleological approach set out in Stubart?

Question 2: Does the fact that the Court doesn’t want to assess whether the additional interest is “non-recurring, unexpected or unusual” a way of saying that these elements are not material or less relevant to the characterization of a windfall gain?

Schwartz v. Canada [1996] SCC (appeal from the FCA)Facts: S was hired by Dynacare while he was still employed elsewhere. Just before S commences to provide his services to D, D retracted its offer. To avoid litigation, D settled for $400K, partly for loss of expected salary, loss of stock options & anxiety caused by the undue notice. Question: Under s.3, 1/ is the payment taxable as an income from employment? 2/ is the payment taxable as an income from an unenumerated source? Under s.56(1)(a)(ii), 3/ is the payment taxable as a retiring allowance?Judicial History: TCC → 1/ no, b/c damages are not salary, wage, or remuneration esp. since S had not commenced employment; 2/ not considered; 3/ no, b/c since S had not commenced employment, he didn’t lose employment, but legal right entitling him to employment in the future, therefore damages flow from breach of K, not the employment.FCA → 1/ yes, when some1 receives compensation for failure to receive a sum of $ that would otherwise have constituted income (from employment), compensation is treated as income from employment; 2/ not considered; 3/ not considered. Plus, reversed TCC’s holding according to apportionment of damages (documentary evidence shows that $342K were received as compensation for losses of salary & stock options).Holding: 1/not argued; 2/no b/c termination payment is dealt w/ under s.56; 3/no b/c employment doesn’t begin until employee provides services;Analysis:Majority (La Forest J.):2 contentions of the Crown:1. Part of damages are taxable as income from an enumerated source (employment contract) under s.3(a)

To overturn a finding of fact of trial court → there must be overriding & determinative error in assessment of the balance of probabilities; deferential approach doesn’t apply when a second appellate court reviews first appellate court;

FCA relied on letter where Ps exchanged offers and demands as to damages → however, no ev. that the apportionments discussed were agreed on. Oral ev. contradicted this

finding & FCA had no basis to overturn TCC in assessment of credibility of the witnesses. FCA was wrong to allocate $342K to income relating to salary & stock options;

Absent a proper determination of the factual situation, damages cannot be taxable on the ground of [income from employment];

o London surrogatum principle, approved by Manley: “compensation that would otherwise be a business profit is to be considered as income from business for tax purpose” → applied by the FCA in the context of employment, but contradicts Atkins, which found that such damages can’t be characterized as income b/c the source isn’t employment but breach of K.

Anyway, Crown didn’t argued in this appeal that it was income from employment, but rather that it was [income from unenumerated source] (Atkins didn’t consider whether breach of K might fall under unenumerated source) → under s.3(a), “other sources than enumerated are […] taxable”.

o S argues that “other sources” refer to sources listed under s.56(1) → overlooks the introductory part of s.56(1): “w/o restricting the generality of s.3”.

o S argues that only listed sources should be taxed for policy reasons → no, existing policy reasons to tax income from sources (source = ability to pay);

Therefore, it might be that damages from wrongful dismissal be an unenumerated source of income → however, considering that Parliament amended the Act to modify jurisprudence, termination payment should be assessed under retiring allowance.

o If Legislature specifically dealt w/ termination payment under s.56(1), it would be inconsistent to find that termination payment are also taxable under the general provision of s.3(a).

2. Whole damages taxable as retiring allowance. Interpretation of tax legislation should be subject to ordinary rules of construction (≠ strict

construction anymore); Employment means “position of an individual in the service of some other person” →

ordinary meaning excludes prospective notion of employment;o No possible loss of position that has yet to be held as defined under “retiring

allowance;o Distinction btw start of K relationship agreed upon & moment at which the

employee is bound to start providing service; Plus, not consistent w/ reading of s.80.4(1) that distinguishes btw employment & intended

employment. Presumption that words of Parliament are deemed to have the same meaning throughout

a same act → no reason to rebut the presumption;Loss of employment cannot occur before S became under obligation to provide services to Dynacare.NB: it is left undecided whether damages from wrongful dismissal is indeed income from an unenumerated source (although it doesn’t seem opposed to it) b/c court turns to Parliament intent which doesn’t consider these damages as income, therefore turning to assess the problem under the rubric of retiring allowance. Dissent (Major, Sopinka, Iacobucci JJ):

Sole point of disagreement: whether the general provision of s.3(a) applies to unenumerated sources → acc. to dissent, it shouldn’t have been decided b/c it wasn’t at issue & the conclusion is wrong anyway;

Contradicts jurisprudence establishing that monies which don’t fall w/in the specifically enumerated sources are not subject to tax;

If s.3(a) is meant to include all possible sources, then s.56 as “other sources of income” is useless, which is against the canon of statutory interpretation

o Although, I think this is a wrong interpretation of the meaning of s.3(a) as a

general provision. S.3(a) reads as "including, without restricting the generality of the foregoing" - it seems to me like the interpretation of s.3(a) as giving some non exhaustive illustrations is more persuasive. Therefore, when s.56 states other sources of income, it is just a more detailed provision complementing the generality of s.3(a);

Different interpretation of Curran & Fries:o Curran: holds that the money was received in exchange of services, therefore

disposed on the basis of taxability provided by income from employment (enumerated source);

o Fries: since the strike pay didn’t fall w/in the purview of enumerated source, it wasn’t taxable;

Conclusion: s.3(a) should not apply literally b/c it would permit taxation of income from any source whatsoever when these sources have to be assessed prudentially.

Does the Surrogatum principle apply to enumerated sources & when it comes to unenumerated source, the general provision of s.3 kicks in? Is it law or only obiter as the dissent states it?

Johnson v. Canada [2011] TCCFact: J. had been involved in a Ponzi scheme, but lucky enough, she had been on the receiving hand of the fraudulent plan. Lech had managed to get money from several people by making them believe that he was investing the fund. He also said that the returns were free of tax b/c it was going through his family trust. Question: Are net receipts (total amount that J. received – amount that she paid to him) income from a source?Holding: No.Analysis:Woods J. –

J. argues that there is no source of income. R v. Hammil → fraudulent scheme can’t give rise to a source of income from the victim’s perspective. While she’s not a victim, she was an unknown participant in a fraud, therefore triggering the application of this principle.

The Crown argues that there is a source of income b/c, following Cranswick, J. provided Lech w/ $ expecting that $ would generate income; J. made efforts to receive the payments & payments were expected & sought by J; payments made in consideration of the capital provided to Lech & earned as a pursuit of gain. Therefore, it cannot be said to be a windfall gain and consequently, there is a source.

Could one prove that since the income doesn’t fall w/in the exceptions (inheritance, gift, windfall gains), there is necessarily a source?

Cranswick def/income/: that which is typically earned by the source or which typically flows from it as the expected return. In this case, it doesn’t apply:

Nothing earned w/ capital (J. thought it was, but a source is not one imagined); Net receipt wasn’t in satisfaction of an agreement (Lech had no intention to pay J. profit of

the investment); No enforceable claim to the net receipt (claim that capital be invested on her behalf only); No organized effort to receive the net receipt (J. sought investment returns, not fraudulent

funds); No payment sought (J. didn’t seek fraudulently obtained funds); No foreseeable element of recurrence (while the believed nature of the payment by J was,

the true nature of the payment wasn’t); No consideration (no bargain on the part of Lech);

Finally:

- Not a loan: while the post-dated cheques could point in the direction of a lender/borrower relation$, Lech acknowledged that the arrangement was a trust;

- The source isn’t income from business b/c J. was not part of the illegal scheme;- No Surrogatum principle b/c payment were not made in lieu of income pursuant to a legal

right.Conclusion: the net receipts are not income from a source.

Is it considered thereto as a windfall gain? oui

Ratio: source of income has to be assessed w/ respect to the true nature of the income, not against the make-belief nature of the income; income is earned by a source or what is expected to flow in return from the source.

Ponzi scheme: no income source, BernsteinDef/Ponzi scheme/: fraudulent investment in which the promoter does not invest the funds raised from an investor. Instead, any return on his capital/repayment of his capital are paid out of other capital raised by the promoter from other investors.Concerns for a lucky investor: 1/ whether any net gains he received were taxable; 2/ whether, if he received payments and didn’t recovered his investment, he can recharacterize the payments as capital repayments; 3/ whether he can claim any losses he incurred on account of capital not recovered. Tax perspective → whether there was a disposition of property owned by the TP & whether business was carried on. Capital loss? No, b/c no property was acquired → no source of income from which TP can claim deduction.

Fraudulent investment scheme, CRA- Rules apply to bona fide investors; question of fact;- Situation: TP have lost all of their investment as well as not being able to collect the

investment income they reported in prior year tax return → what is the tax treatment?- Income inclusion :

o All amounts paid in return of investment are taxable income;- Deduction for Bad Debt if the investment income was previously included in TP’s income:

o If payments received, cumulative total of such payments will reduce the amount of the bad debt deduction;

o If investment income wasn’t reported in previous tax report, no deduction allowed;

o Right to deduction is extinguished w/in a year from the discovery of fraud by Crown;

- Losses :o Distinction btw business loss & capital loss, & if capital loss, whether = business

investment loss;- Capital loss if TP was unable to recover the initial investment: - Business investment loss (BIL):

o Def/BIL/: capital loss from a disposition of a share of a corporation that is a small business corporation (SBS), or a debt owed to TP by a Canadian controlled private corporation (CCPC). BIL = available if investment = shares OR debts of a CCPC of a CCPC that was a SBS;

o ½ of BIL = allowable business investment loss (ABIL);o ABIL may be deducted from all sources of income in the year; if can’t be deducted

in the year, it becomes part of the non-capital loss pool for a period of 10 years;

- If investments are recovered after tax deductions received, recovery will be taxable.

In consideration of these cases, we will use the following definition of income:

- It must be the product of labor or capital;- It must be received on a regular/reoccurring basis;- It must represent the creation of new wealth;

2.2.2. WagesS.5 Employment

income1/ income = salary, wages & œ remuneration (gratuities, tips);2/ loss = amount of the loss from that source (s.4, 111);

S.6, 7 Amounts included (value/benefits, living expenses, director’s fees, allocations under employees profit sharing plan, charge for automobile, sickness/accident insurance plan, private employment insurance benefits, etc.); stock options, securities, etc.)

S.8 Amounts deducted (legal expenses of employee, clergy residence, travel expenses, etc.)

S.248 Def /employment/ individual in service of œ person; /to be employed/ performing duties of employment; /office/ position entitling individual to fixed remuneration;≠ business

Dichotomy btw employment & business income → the difference lies in the applicable deductions available for each (+ deductions for business income).

a. Employee vs independent contractor

Wiebe Door Services v MNR [1986] FCAFact: Appellant hasn’t paid Unemployment insurance premiums to his workers for the years 1980 & 1981. TCC holds that they are employees for the purpose of tax law. Appellant challenges the decision, arguing that they were independent contractors and that the TCC erred in applying the organization(integration) test, which should only be used in the case of highly skilled workers.Question: 1/ Are the workers employees or independent contractors? 2/ Does the organization test only apply to highly skilled workers? 3/ What test should apply to determine whether worker is employee or contractor?Holding: 1/ Rescinded to TCC; 2/ No; 3/ no precise formula, but control test is not the sole determining factor – a mix of the entrepreneur test & the “who owns the business” test, applied to the particular fact of the cases. Analysis:K of service → master/servant, employment relation$;K for services → principal/agents, independent contractors;Traditional CML standard: control test → employment relation$, master exercises control over what is to be done and how it is to be done; independent contractors, principal only directs agents as to what they do;

Critics: o If the K contains detailed specification, control may be greater in a principal/agent

relation$;o Test reaches its limits w/ regard to highly skilled professional servants;

Entrepreneur test (MTL v MTL Locomotive Works [1945] – Lord Wright):1. Control test;2. Ownership of tool;

3. Chance of profit;4. Risk of loss;

Organization test (Stevenson Jordan v. MacDonald & Evans [1951] – Lord Denning): In an employment relation$, workers are employed as part of the business & job is an

integral part of the business, while in a K for services, job is made for the business but is accessory to it.

o Critics: showing that w/o the work of the employees, the employer would be out of business is not always representative of the intrinsic relation$ w/ worker.

Therefore: no single factor test, nor a magic formula determining the respective weight of factors in a particular case.Market Investigation v. Minister of Social Security [1968] – Cooke J.:

Is the “employee” performing services performs them as a person in business on his own account?

o Yes: K for services;o No: K of services;

No exhaustive lists of compiled of considerations; control has to be considered, but not as the sole determining factor;

As shown by jurisprudence, contention of appellant that organization test applies only to highly skilled professionals is wrong; but TCC has erred in applying the organization test as the sole determining test. Conclusion: rescinded to trial court for determination.

The Federal Income Tax Act and Private Law in Canada, D. Duff Distinction btw employees/independent contractors; CVL approach:

o Control & subordination as main/sole criterion (e.g. art 2085 CcQ def/employment of K/service performed acc. to instruction & under direction/control of employer);

CML approach & Canadian income tax cases: similar approach → Wiebe Door & general test to evaluate “the total relationship of the parties”;

In QC, question remains: whether control is a factor under the general test or rather the aimed determination.

o Whether, looking at the total relation$ of the parties, there is control on the one hand & subordination on the other; OR

o What is the general relation$ btw the parties? Assessed through different factors such as control/subordination;

Generally → is the characterization based on the CcQ provision or is the provision a factor of the characterization?

Pluri Vox Media v The Queen, 2011 TCC 237Facts: PV engages the services of persons for reviewing text to be published and to be translated. Reesink, sole shareholder of PV, acts as a de facto director, working as an independent contractor for services to the company. Issue: Is Reesink an employee for tax purpose?Holding: YesAnalysis:

According to R & PV, R is an independent contractors b/co He incurs the risk (his salary is dependent on PV’s income);o He was not required to perform services personally – he could have hired a

substitute;

o W/O R, PV could not have carried any business in 2008. Wiebe Door Services v MNR : Review of the possible applying test to determine the status

of the relationshipo Control test is important, although often inaccurate if applied literally;o Lord Wright’s fourfold test: combination & integration of the 4 tests in order to

seek out the meaning of the whole transaction;o Lord Denning’s “organization/integration” test

Whether a person is engaged as part of the business & the work is done as an integral part of the business or whether the work is accessory to the business.

Best synthesis → Cooke J.’s fundamental test:o Is the person who has engaged himself to perform these services performing them

as a person in business on his own account? No exhaustive list of considerations; Control is definitely one of them, but not the only one; Could be own equipment, hires his own helpers, degree of financial risk,

opportunity for profits, among else. In this case:

o R ≠ engaged to perform services as a person in business on his own account;o The control test is vain in this case b/c he is the sole shareholder and it induces a

certain bias;o However it is irrelevant to assess his work (shareholder = separate from function

as a worker);o Financial risk: he incurs risk not as worker, but as a shareholder;o It is not his business but that of PV. He is contributing to PV’s expectation of profit,

although it is not his own. His income is an amount agreed btw them in exchange of its work.

R denies that he is entitled to a “fixed & ascertainable stipend/remuneration” in the sense of s.248 def/office/, b/c at the beginning of the year, it is impossible to ascertain his remuneration.

Remuneration paid to R was ascertainable in practice, while not necessarily predictable.

Therefore, R is an employee.

b. Income inclusion

Goldman v. MNR [1953] SCJ no 7

Employment relation$ carries w/ it a withholding obligation on the part of employer (s.153) b/c payer of income is responsible for the tax associated w/ the income she pays out;

o More careful about employee/independent contractor status; S.227 states that a person upon whom tax is withheld cannot sue the third party withholder,

and that the amounts withheld by the third party are held in trust of Her Majesty. o Odd: it could be interpreted as if a person’s income is only partly earned by her and

the rest is earned by the Queen;o Consistent w/ foundational stand that “but for the state, the market transaction that

results in the production of income would not occur”;o Although, it creates a paradox: if a tax withheld does not even belong to the earner

by law, how could the state tax it as such to begin w/?

Solved by s.153(3): “amounts withheld are deemed to have been received by the earner”.

c. Cost recovery Income is a NET concept

o New income + product of labor/capital + received regularly; What is “new income”?

o It takes money to make money: what costs are out of the new income category?

S.8 is the general rule for deductions from employment income;

TAs.8

Deductions employment income

1/ Those amounts are deducted from the TP’s income from office/employment:

- Legal expenses incurred by TP to obtain salary/wages owed to TP by employer;

- If TP is selling property/negotiating K on behalf of his employer, he can deduct the amounts expended for the purpose of earning income if it was not otherwise reimbursed by employer;

- If TP’s employer is engaged in transports, that he was required to travel, eat and lodge outside of town and that costs have not been reimbursed, he can deduct these costs from taxable income;

- If TP paid for annual professional membership, office rent or salary to an assistant, supplies or membership in a trade union, he may deduct those;

- If TP had to pay an employer’s premium under the employment insurance Act or an employer’s contribution under the Canada Pension Plan, it can be deducted from his income;

2/ These are the only deductions possible from an office/employment income.

- The deductions are trying to distinguish btw consumption for personal use & investment necessary to create employment income – hybrid expenses;

- An income tax = tax on combination of consumption & changing value of savings over time;o Every income tax system must distinguish btw spending on personal items, which

should not be deductible, and spending money to make money, which should be.

2.2.3. ProfitsTAs.9

Business income charging provision

1/ Bus. income = TP’s profit from bus;2/ Bus. loss = loss from bus;3/ income from property ≠ capital loss from disposition of property;

To have a business income, you need a business + profit from business; To have a property income, you need a property + profit from property;

o Although, doesn’t include gain from disposition of property, only income stream generated by holding property;

A. BusinessDef/business/ inclusive list → profession, calling, trade, manufacture or undertaking of any kind whatever and an adventure or concern in the nature of trade but does not include office or employment;

Interpretation of business often comes from cases arising from the world of gambling.

CRA Interpretation Bulletin – MNR v Morden [1961] CTC 484 Profits from bookmaking/gambling establishment (legal or not) → income from business; “Business of gambling” →subject to tax on income derived from gambling itself; can be

assessed by:o Degree of organization in activities;o Special knowledge/inside information reducing the element of chances for the TP;o TP’s intention to gamble for pleasure vs intention to gamble for profits as means

of gaining a livelihood;o Extent of TP’s gambling activities (frequencies and number);

Earning from illegal/illicit business ≠ exempt from tax.- Also implicit: whether there is a risk that losses flowing from gambling be deducted if profit is

found to be income from a business.

Leblanc v The Queen [2006] TCC 680Facts: The brother Ls did not have jobs, but lived on the proceeds of their sports lottery play; they moved near the Qc/Ont border to facilitate multi-jurisdictional gambling; they chose long shots w/ high payout potentials; they used computer program to come up w/ combinations of long shots; they would do this all day all week; they bought significant number of tickets at various retail outlets & even got volume discounts from retailers; they used up to 15 paid helpers to handle the purchasing of the pre-ordered tickets. In the 4 years at stakes, they win more than they lost: each $2.75 million of net winning.Question: whether the gambling activities are pursued as a business.Holding: No.Analysis:

Expert’s report on gambling on sport lottery:1. Very low chances to win;2. No possibility to beat the odds;3. Payouts are not reflective of the true odds;4. Skill is irrelevant;

Acc. to s.9, para 40(2)(f): loss/gain from the disposition of a right to receive winnings on a bet, in connection w/ a lottery system is nil;

But gambling activities can nonetheless flow from a business intent – how do we know? 3 categories:

1. Gambling is pursued as a pleasurable activity. Profit is not taxable as a business income even if regular, compulsive and have some sort of organization or system (if the system doesn’t help minimizing the risk or not in a significant manner);

Graham v Green; R v. Rumack; ; R v. Balanko2. Gambling is an adjunct/incident of a business carried on (casino owners gambling

in his own casino, or horse trainer who puts bets on his races);3. When the gambling activities are pursued as a result of the person’s knowledge or

skill, in the objective to earn a livelihood in a gambling game in which skill is a significant component;

Luprypa v. the Queen; This case falls under the 1st category:

While they were organized, their “system” wasn’t one of risk minimization

– they would bet on longshot wagers. The fact that they won doesn’t show that they had a business (otherwise,

the fact that they would have loss would have proven the contrary, which is a false logical deduction);

Evidence only shows that their strategy was to bet massively and recklessly;

The administrative complexity of their purchasing pattern was the result of the OLG’s imposition of limits on the number of wagers per ticket, not on their planned will to manage the risk;

The high number of bets is not indicative of anything other than a tendency to bet heavily;

The game they were playing could not be overcome through skill or experience;

Ratio: a business implies a feature of risk minimization or management that gambling generally lacks; addiction needs to be distinguished from a vocation, habit should not be taxed; when skills modify the odds, the activities are more likely to be assessed as taxable income from a business. Obiter: J. raised some policy considerations which he however didn’t discussed but left to the exercise of the legislature:

- We might be inclined to think that gambling activities should be taxed when it involves so much money;

- But gambling has never been taxed in Canada and it is a thought deeply embedded in the Canadian fiscal psyche;

- One could argue that there is no difference btw a business & gambling activities for they both are seeking profits;

o But this argument overlooks the fact that games of pure chance lacks the features of a trade;

- If gambling wins are subject to tax, the corollary is that losses should be deductible.

B. PropertyDef/property/s.248(1): property of any kind whatever whether real or personal or corporeal or incorporeal; including

- A right of any kind whatever, a share or a chose in action;- Unless a contrary intention is evident, money;- A timber resource property; &- The work in progress of a business that is a profession;

Everything you own is “property” for tax purposes;

Issue: identifying income from property

- While everything you own may be property, not all property generates “property income”;- Property income derives from ownership of the property, and not from the sale thereof;

income streams arising from owning assets;- It can also be hard to distinguish btw property and business income;

C. Classifying business and property incomeTA

s.12Business/property income

1/ income of TP includes income from business/property + list of items included;

The meaning of ‘Enterprise’, ‘business’ and ‘business profits’ under tax treaties and EU tax law, Kim Brooks

- Certain provisions require that business and property income be distinguished;o Property transfer btw spouses, income from property is attributed to the

transferor;o Restriction on deduction of capital cost allowances only applies to property

income;o Allocation of income to ea. province applies diff. for property & business income;o Tax rules for non-residents distinguish btw property & business;

- Distinction based upon the amount of services the TP performs in earning income;o Passively – property (renting small number of units);o Actively – business (renting large number of units & providing management

services);- Distinction very important in 2 instances:

o Canadian-controlled private corp. carrying business benefits from a tax rate reduction of 16% (many people tried to claim their property income as business activities to benefit from the credit);

o Canada’s foreign accrual property income (FAPI) rules: corp TP earns business income in a country w/ which Can has tax treaty, income is exempt from Can tax; however, if it is property income, income is taxed on accrual basis in Canada;

- Bright-line test:o Property investment is not a business activity unless the corp has at least 5 full-

time employees;

Christians say that bright-line test is wrong, but done – so no arguing on this;

Active/passive distinction rule comes from Lois Hollinger v. MNR [1972] CTC 592;

- w/o the active & extensive business-like intervention of its owner (e.g. bonds, debentures, shares, real property, dividends, interests, rents, royalties);

- Confirms that property income is commonly thought of as passive investment income;o There is no “passive business income”; business income is deemed active;

S.12(1)(c) Def/interest/: “any amount received or receivable by the TP as payment of or in satisfaction of interest”

- Any amount you charge someone for the use of your money over a time period;o Rents: “dependent on the use of or production from physical or real property”o Royalties: “dependent on the use of your intangible or intellectual property”o Dividends: “payments made to shareholders out of corporate business profits

(s.12(1)(j))

S.12 includes number of items that are not intuitively assessed as business/property income:

- Income that arises when debt is forgiven (s.12(1)z.3)o If an obligation to repay is attached to a receipt, the receipt is not income; however,

if the obligation is erased, the amount previously received becomes income.

D. Determining “profit”- Only profit matters for tax purpose, not all receipts; it takes $ to make $;

- Symes v. Canada [1993] 4 SCR 695: the term profit presupposes “business expense deductions”;

- Personal costs – not deductible; costs incurred for the production of income – deductible; - If TP are taxed on income, it needs to be “new income” and therefore net profits; gross

receipts could be a base for taxation, but are not income;

Hammill v. Canada 2005 FCA 252Facts:

- H is engaged in a business of buying precious gems for the purpose of resale; when he decided to sell his collection, a corporation contacted him on behalf of the first corporation w/ whom he was acquiring the gems in order to give him advice for the resale;

- Premier (the 2nd corp) presented a first offer but H had to pay some upfront fees to Premier; the sale failed, H was not reimbursed for the fees, and Premier came up w/ this kind of scam 5 times; H lost $1,600,000; never asked for receipt and never questioned Premier;

- Premier was charged for theft and fraud and disappeared w/ the gem collection of H;- MNR recognized that H was engaged in a business and H was allowed to claim the loss of

his collection as a business loss but he wasn’t allowed to claim the $1,6M as expenses deductions;

Issue:- Whether expenses were incurred to earn income from a business w/in the meaning of

s.18(1)(a);- If so, whether expenses were reasonable w/in the meaning of s.67

Holding: No, no.Analysis:

- Facts establish that the fraud extended to the amount paid for the gems in the 1 st place; the whole transaction was a fraud from the start. This is incompatible w/ the existence of a business and the court was right in not taking into account the state of mind of the TP ; a fraudulent scheme from beginning to end cannot give rise to a source of income;

- H argues that since MNR admitted that he was engaged in a business, the court is bound to find that he indeed was. But the rule of evidence counterfeits this claim. Therefore, he couldn’t claim expenses made for gaining income under s.18(1)(a);

- Although there is no need to consider s.67, the Court notes that s.67 have treated the issue arising under that provision as one of magnitude or quantum; the word “reasonable” would appear to relate primarily to the size or the amount of the deductions claimed and not to the type of expense.

o S.67 is a statutory means of controlling excessive or unwarranted expenditures ONCE a source of income is found to exist;

o It is not the existence of a source of income which ought to be questioned, but the relation$ btw that expense and the source to which it is purported to relate. If the expense is found unreasonable in relation to the source of income, s.67 provides a mechanism “to reduce or eliminate the amount of the expense”; at the first step of inquiry (establishing existence of a source of income and relation$ btw expense and that source), Courts ought not to second guess the business judgment, but they can at the second step w/ s.67.

Christians on Hammill:

- The guy was in the deal… no way he was that dumb;- We have to decide what is reasonable? Qualitative (whether making the payment was

reasonable) or quantitative (amount is paid is reasonable)?

- S.67 is quantitatively reasonable “to relate primarily to the size or the amount of the deductions claimed or quantified and not to the type of the expense”

o But in deciding whether it is reasonable, you have to have found that there was a business first.

2.3. When should we tax?- “Ea. taxation year” – arbitrary designation; just a convention to administer income tax;

- Relevant provision: S.249(1)(a) – For a corporation, taxation year is the fiscal period (period for

which accounts are made up & doesn’t exceed 53 weeks) S.249(1)(b) – individuals other than testamentary trust, taxation year =

calendar year (although not sufficiently clear)

2.3.1. Finding appropriate triggers- Gov’t doesn’t want to wait too long before counting income but doesn’t mind if individuals

wait to subtract their deductions;- 3 options to adjust the timing for tax-related adjustments for PROPERTY:

- Recovery upon purchase (now): TP deduct the cost of business expenses as they are incurred; Problem: Assets are not always expenses: they can be capital investments,

equipment used over a period of years;- Recovery upon disposition (later):

TP waits until disposal of asset & then allowing a loss equal to the difference btw initial cost & resale value;

For e.g: X buys a computer for 1000$ and sells it back 5 years later for 300$; the $1000 is capital cost (capital basis), the $300, the return of cost basis;

Personal use: the 300$ is not includible in taxed income b/c it is a return of basis; the lost value of 700$ is not deductible b/c not an investment for profit (s.18(1)a);

Business use: the 300$ is not includible in taxed income b/c it is a capital cost recovery (your money); but the $700 is deductible b/c it was used to produce business income;

2.3.2. Following economic reality

- Recovery during the term (later): trying to follow economic reality; it is called the capital cost allowance;

Instead of making TP wait for ultimate disposition to recover her basis in the form of a deductible loss, she can estimate the ongoing reduction of the asset’s value & deduct a share ea. year and make the necessary revisions at the date of the ultimate disposition;

Only allowed for assets that are in fact depreciating (reducing in value) over the term; depreciable property can be recovered during the term of ownership while non depreciable property have to wait for recovery through disposition;

- Cost recovery is a 2-step inquiry:- Should the item be subject to recovery at all? (Is it deductible?)- When the recovery should be taken into account? (When can it be deducted?)

- Deductions that can be taken in the current year (expenses or current expenses);

- Deductions you may have to wait until later to take (capital expenditures); Capital expenditures may be depreciable – thus recoverable during the term

of ownership – or it can be nondepreciable - thus recoverable only at disposition;

- Why it matters? The tax assessment period is based on a social time measurement

convention that may bear no specific economic relation$ to the activity; generally calendar year;

All expenses made w/in that year, whether or not the value has been used for incurring income during the same year, tax assessment is based on the outlays of the calendar year;

Therefore, it matters when you get to deduct your expenses and capex since it will be deducted from a particular income of a particular year;

Time value money def/Wikipedia/- 100$ loaned at 5% rate for a year is worth 105$;- Present Value (PV); Future Value (FV): PV = FV – r x PV = FV/(1 + r)

CRA wants $100; you can pay 1/ now2/ in 5 years3/ in 50 years: the reason you want to pay in fifty years is nominal value; CRA is not charging interest or penalties, it’s only charging 100$. 100$ later is worth less than 100$ today. Therefore, you want to pay the amount the latest possible.

- You put the money in a saving account, 1% every year; in 5 years, you have 105$, 50 years, you have 150$; the actual return is greater;

- At the same time, there is inflation: the dollar increases in value; assessed on the basis of the Consumer Price Index (CPI); 2% is a good, stable rate of inflation;

- However, if your interest rate is 1% and inflation is 2% it means that your 105$ in 5 years cannot buy what you can buy w/ 100$ now.

- The problem w/ paying later is that while the interest rate is certain, the inflation rate is not. Therefore, it is impossible to predict the nominal value of money later. That riskiness translates into a sense of nominal value versus real value. Time becomes this risk factor.

- A taxpayer is always working w/ gov’t in nominal value; this fact alone incentivizes the TP to delay income and accelerate deductions;

- You want to pay less every year so you can invest your money so you counterfeit the risk of inflation by investing your capital;

- Time value of money has an impact on TP and gov’ts;- Income taxation: if TP can create deductions in a taxable year, she pays tax on PV

rather than FV (i.e. w/o incurring interest or penalties), thus saving a factor equivalent to the discount rate;

You want to defer what you are going to pay to the next tax base, b/c you want to have a lesser tax base in order to pay less taxes on your income. However, the real tax issue is not tax rate but rather what is the tax base.

Depreciation: taking away some of the tax base;

OE B P CG O

Tax base 2015

Tax base 2016

Tax base 2017

50% go to gov’t

A. Deduct at all- Depends on the nature of outlay;

o S.18(1) = general rule: you may not deduct any outlay or expense unless and to the extent it was made or incurred by TP for the purpose of gaining or producing income from the business or property”;

Presumption that if your purpose in making the outlay was not profit-motivated – not deductible (confirmed in s.18(1)h on prohibition against personal expense deductions);

Although, s.18 is not the last word on what is deductible;o Conceptual problem: distinction btw “personal/living expenses” & “income-earning

expenses”; S.248(1):

Personal/living expenses: for the maintenance of property which is not connected w/ a business;

- Judge-made test based on s.9(1) & s.18(1) – Business practices test o Whether it was made/incurred by the TP in accordance w/ ordinary principles of

commercial trading or well accepted principles of business practice; Royal Trust Company v MNR [1957] Ex. C. J. no 7, confirmed in Symes v.

Canada;

Business expenses, CRA bulletin- Deduction allowable for any reasonable current expense made to earn business income. - Deduction not allowable for personal expenses, for other sources than business income,

and for expenses incurred to buy capital property;

- Most of cases have to do w/ drawing the line btw personal/business expenses;- Some involve policy matters:

o What to do w/ illegal payments? Smith v Canada [1917-1927] CTC 240 TP must include gains derived from illegal activities – consistent w/ a general

public policy goal regarding not rewarding scofflaws; But sometimes, scofflaws may be rewarded:

Angle v. MNR [1969] TAX ABC 529 – TP was allowed to deduct ordinary expenses incurred for the purpose of producing income in an illegal business;

Should policy reasons be used to deny that deductions?

Question 24

A is half personal, half business B is rental – therefore it’s businessC is personal

We are assuming B is in the higher bracket of marginal tax rate – approx. 50% in Qc (A1)If I got 100$, I pay 50% therefore, 50$; If I got a 20$ tax exemption for charity, I pay 50% on 80$, therefore I pay 40$ of tax. The difference btw my tax liability is 10$, and the exemption is 20$. 10$ of 20$ is 50%. Therefore, the marginal tax rate = the value of exemption. If B pays 900$, she is out of 900$. If A & C each pays 150$, she is out of 600$. If she is exempted of 50% on 900$, she will get 450$ (assuming she can deduct the whole 900$) and be out of 150$. Therefore they will all pay an equal share of 150$ each.

Although, it depends on the assumptions (1) & (2).See Jeff’s formula

B. Deduct now- Once deductible nature of an outlay is ascertained, the question remaining is when the

deduction should operate ; o S.12(1)(b): no deductions are allowed for any “outlay, loss, or replacement of capital”

except as provided; w/ s.12(1)(a), it draws the lie btw current expenses (deductible in the year in which they are paid) & capital expenditures (cost recovery or deductible upon disposition);

Current or capital expenses, CRA bulletin- Current expense: usually recurs after a short period;- Capital expense: gives lasting benefit or advantage;- To better distinguish them, is the expense:

o For a Lasting benefit? If so, capex;o To maintain or improve property? Maintain: current; improve: capex;o For a part of a property or for a separate asset? Part: current; separate: capex;

- Then, if not conclusive:o What is the value of expense? If considerable in relation to the value of property:

capex;o Are expenses made for purpose of putting property in suitable condition for use?

If so: capex;o Is the expense for repairs made to an asset in order to sell it? If so, capex;

As soon as you have tax, the tax system is NOT neutral – some people will change their behavior accordingly, other will not. But then the consumption system will respond to the tax system, which will respond to the consumption system;

- The point of view of nowhere!

- Tax creates a benefit and cost systemically whether you want it or not, and some people will answer to it (especially people w/ tax planner);

- Therefore, a dollar is not a dollar – it depends on what, when, how you can deduct it and at this point, what will be the real value of it? – Expected tax benefit – accelerate income deductions

- Expected tax costs – delay income inclusions (time value of money --- makes it less painful to wait)

C. Deduct later- Capital cost allowance (CCA): regime for allocating the cost of tangible depreciable capital

assets (under a cost recovery time set for taxation); only applies to business income. o Regulated under s.20(1)(a);

- Intangible capital assets are not subject to depreciation, but if they are eligible capital expenditures (ECE), they are eligible for deductions under s.20(1)(b) – operates like the CCA regime but may be taken vs business, property, employment income.

Question 25- Jane has a business (but she’s not a corporation);- She spends $300,000 for a printing press;- Nominal value of $300,000, but all outlays has an expected tax benefits;- Expense implies that she will deduct all benefits the same year;- We assume that Jane has enough income to take the deductions associated w/ the outlay;- We assume that she’s in the top bracket of tax rate; 50%

- So 50% of 300,000$ = 150,000 is the real price she pays; this is if she deducts all the same year;

- Jane wants to take all of it the sooner possible – b/c of preference for sooner deductions;- BUT this is not an expense: it is a capital expenditure: she cannot deduct it all at the same

time;- Every time Jane sells a good that she produced using the printing press, there is a cost

associated w/ the sold good; every $ she has to take out of her pocket is $ that is needed to produce income;

- The price of the good sold includes the cost of the good sold; the printing press cost is INDIRECTLY in the cost of the good sold;

- Q: how do we allocate the cost?o How long will use the printing press? 5 yearso How many goods will you produce?o How much per item?o Costs of maintaining printing press?o Salvage value? If we say 10% of the initial price = $30K

Therefore, we need to allocate $270K over the term; If we print 270 000$/5 = $54K you want to deduct every year until you sell

the printing press; STRAIGHT LINE DEPRECIATION – depreciation is NOT going to follow actual production;

- This supposes that capacity is equal over the year (that you sell a fix number of issues every year)

- Need rules to be sure that people don’t go crazy when assessing these different criteria:o Regulation 1100 in Part XI Income Tax Regulationso AC: there is a weird construction in s.20 about that(…); s.13 definition of

depreciable property; see also s.248 for definition of capital cost; “available for use” restriction; see also s.26

Jane got it in August, so it’s not available for the whole year the first year;s.20(1)(a): can she get a deduction?

s.248: what is a capital cost? Sends us to s.13(21): defines depreciable property;

s.26 exists as an anti-abuse rule.

Capital cost allowance, CRA bulletin- Capital cost: actual cost of a depreciable property;

o Tax Act can change the capital cost;- S.18(1)(b):

o Prohibits deduction of any outlay, loss or replacement of capital, payment on account of capital or any allowance for depreciation, obsolescence or depletion (unless specifically allowed);

- S.20(1)(a):o Allows a deduction in computing income from business/property, of any amount

allowed by Regulation in respect of the capital cost of a property (capital cost allowance);

- Part XI Regulations: types of depreciable property are categorized and attributed a rate of CCA allowed;

o CCA is calculated as a percentage of the undepreciated capital cost (UCC);o Most CCA rates set out in s.1100(1)(a) – but restrictions such as rental or leasing

property;

o CCA available but not claimed is not “carried forward” to the next year; but remains in the UCC balance for CA claims in future years;

- Classes of depreciable propertyo Must fit w/in the description of a class in Schedule II/part XI of the Regulations;

- Capital cost of propertyo Full cost to the TP of acquiring the property; includes

Legal, accounting, engineering or other fees incurred to acquire the property;

Material, labour, and overhead costs attributable to the property (but not for any profit which might have been earned had the asset been sold);

For building: soft costs – costs attributable to the period of the construction, renovation or alteration of the building;

- CCA may be claimed only for property TP owns or has a leasehold interest in;- TP is deemed to have acquired a depreciable property at the earlier of (a) the date on

which title is obtained; (b) the date on which the TP has all the incidents of ownership (possession, use, risk);

- 50% rule – property acquired in the yearo S.1100(2) limits CCA claims of acquisition of most depreciable property to the

amount otherwise available less 50% of the CCA attributable to net acquisitions, determined on a class by class basis.

Net acquisitions: cost of acquisitions in the year in excess of net proceeds of disposition in that year; no effect where the lesser of net proceeds of disposition +capital cost of property exceeds additions to the same class;

Exemptions

2.3.3. Fixing timing errors- What happens when TP’s allowable deductions exceed her income from the source?

o 2 things to keep in mind: The tax year is a fixe and arbitrary bounding of time that has no economic

significance; Progressive rates means that bunching income in any one year will tend to

increase TP’s burden relative to a TP whose income is more evenly distributed;

- How should we take fluctuating inflation and discount rates into account?o E.g. Income averaging (see s.61 & 61.1)

Question 26Year 1 Year 2 Amount Marginal tax

rateEffective tax rate (tax over dollars)

A 50K 50K 50K and 50K 15742$ 15.7%B 130K - 30K 130K and 0 27 094$ 20.8%

Section 117 CRA Total tax per bracket15% 44 701$ 6705$22% 89, 401$ 9834$26% 138, 586$ 12,788$29% Over. ∞

Income averaging – not optimal b/c you don’t want people to escape their real tax bracket, it’s hard to assess, etc.

B: 130 – 30 for year 1; divided on 2 years, so 50K every year; so averaging = 15741$ for both year

CARRY OVERS (loss deduction):

- Year 1: 130K- Year 2: -30K- Year 1 – year 2: 100K income; 19295$ marginal tax rate

Income averaging deserved to die. Let’s not revive it, Kevin Milligan

- For people who have volatile income year-to-year, a progressive tax system can impose a heavier burden on that person than someone w/ the same total income split evenly across the years;

- Income averaging: fictively shifts income out of high income years into lower income years for tax purposes; this shifting is expected to deliver lower average tax burdens; but income averaging was put to rest in the 1988 tax reform;

- Why it should not be revived:o It became extremely complicated to make sure high-income people didn’t use it as

a tax dodge; adjustments for inflation; special rules for trusts; substantial administrative burden;

o Less tax brackets than in 1971 when enacted (there were 17); w/ only 4 brackets, volatile income creates fewer problems;

o Tax rate structure is flatter: before tax rate from 11% to 80%, now from 15% to 29%; plus, at higher tax credit like child benefits and GST credit for higher income, so obviates the need to shift income out of high income year;

Alternative to income averaging: loss deduction transfers in another tax year;

- S.111(1)

2.4. How much should we tax?- Adam Smith: “individual should contribute as nearly as possible in proportion to their

respective abilities”;o Best kind of tax: one that accorded w/ one’s ability to pay it;o Why this “ability to pay” idea endures over the time?

Capital: mix of land and labour (see Bellingham, p 45 for the origin of capital gain in the disposition of property); capital gain is unrealized value. Haig/Simons.

- Realization: if you had to pay tax on unrealized value, you wouldn’t necessarily have the money, so you would have to sell your asset.

Labour = source of income of employmentCapital + labour = source of businessCapital = source of income

2.4.1. We should be fair- Ability to pay as a means to achieve fairness;

Royal Commission on Taxation, Report- Comprehensive tax base

o Taxes should be allocated according to the changes in economic power of individuals; source doesn’t matter; expectation/effort for actual profit doesn’t matter;

o Most employees are now taxed on a comprehensive base; only for a few would it involve a great broadening (e.g. property holders);

o It requires taxation of capital gains on disposition of property; Capital = source of income; By levying a tax on “income” the distinction btw the 2 concepts takes on

great significance b/c capital is not income;o The present distinction btw kinds of gain is inconsistent w/ our concept of what

we believe “income” is for purposes of determining the individual’s capacity to pay tax;

A $ gained through the sale of a share, bond, or piece of real property bestows exactly the same economic power as a dollar gained through employment or operating a business;

According to a principle of equity, both should be taxed the same;

Although reform seems necessary, it isn’t so sure that income tax is not the best means to distribute the tax burden.

Drawing the boundaries of tax justice, Allison Christians- In the Royal Commission on Taxation (1962), mandate to examine the existing tax system

in Canada and make recommendations to ensure a steady flow of revenue; PM Diefenbaker asked for changes that may be made to achieve greater clarity, simplicity, and effectiveness; scope: finding new sources of tax in a time of public demand for an expanding welfare state;

- However, the Commission felt it couldn’t examine this question w/o considering the normative ground of the tax system;

- 3 major principles in Commission’s approach to design a just tax system:A. Taxation as a matter of state choice

- Fairness as the primary goal, b/c taxation is a matter of choice for any state; if equity were not of vital concern, taxes would be unnecessary b/c state could simply commandeer what it needs;

- Taxation is only necessary in a society that concerns itself w/ justice; if the state need not concern itself w/ justice, it need not tax at all, so that if it does choose to tax, it must necessarily do so out of a duty to pursue justice;

o Taxation is not necessary to raise revenues (e.g. producing resources via state-owned enterprises, direct seizure from private sector, state monopsony, deficit financing, monetary policy, currency manipulation); non-tax revenue typically undertaken w/ regard not to the distributional effect, but rather on the pragmatic effectiveness; in a democracy, sheer availability is not a sufficient threshold to justify revenue extraction;

o Pursuit of justice as reason for state to engage in taxation (requires explanation for any decision to deviate from that standard); requires principles, but also exceptions;

B. Income taxation as the just choice- Justice requires the state to identify a normatively justified tax base and then explaining

any deviation therefrom;- Commission proposed that normatively justifiable tax base had to be one that took into

account the relative economic positions of all the members of society – ability to pay;- Commission emitted 2 critics of the current tax system:

o People in essentially similar circumstances do not bear the same taxes;o People in essentially different circumstances don’t bear appropriately different tax

burdens;o Proposition: discretionary economic power = product of the tax unit’s total

economic power & fraction of the total economic power available for the discretionary of the unit;

- The just tax system must be designed to determine an appropriate amount of tax on the basis of the TP’s combined total economic power;

C. Taxpayers and their income: the thresholds to just taxation- State must measure the total economic power of some category of people designated as

TP; - Total economic power to be measured by constructing a comprehensive tax base (Henry

Simons & Robert Haig); so long as the ultimate tax policy choices made w/ respect to the comprehensive tax base involved principled compromises, a tax system can be just;

- Failure: Canada came to rely heavily on income taxation, not on general ability to fulfill the constitutive threshold act of measurement.

2.4.2. But maybe a buck is not a buck- As seen previously (supra def/business & property income), there is distinction btw an

income stream that is generated by holding an asset and the gain from the disposition of the asset;

o Gain from disposition = accumulated appreciation gone untaxed during holding period;

o Loss = accumulated depreciation not accounted for during holding period;- Gains and losses are not accounted for unless realized – generally happens when transfer of

ownership;- These gains and losses are addressed as capital gains and losses – net gain = capital income;

net loss = capital loss;- Despite Carter’s admonition that “a buck is a buck” – preferential rate for capital gain and

limitation on capital losses;

The case for a capital gains preference, Cunningham & Schenk- Easy to avoid paying tax on capital gains – intuition that revenue-maximizing rate

necessitates a CG rate lower than on income to induce TP to realize gains they would otherwise avoid; thesis: tax is not acceptable b/c it raises the needed amount of revenue; a preference for CG needs to be justified in virtue of its efficiency and its equity – but it doesn’t seem to hold on to the evidence;

Origin of the problem: imperfect treatment of CG under current laws- CG pref. flows from current imperfections; the fact that income produced by an asset is

measured as an ex post accounting of its change in value results in total mismeasurement of income from capital assets.

- CG in a normative Income Tax – arg. for CG preferenceo Bunching

Arg: the realization rule forces TP to report in 1 year CG that have accrued over several years therefore subjecting the gains to higher marginal rate;

Resp: not really a current problem – CG generally realized by TP already in highest bracket; taxation on realization rather than accrual doesn’t force TP into higher bracket, esp. since top marginal rate is reached at relatively

low threshold; Although, for TP who experience bunching (e.g. once-in-a-lifetime

sale of stock to fund college education would be taxed at top marginal rate): CG preference still not the answer: not targeted, even applies in cases where no bunching & applies to TP whose top marginal bracket remains constant – it generally just compounds the advantage of deferral. Averaging provision would be more appropriate.

o Double taxation of corporate earnings Arg: corp. income taxed twice (corporate level when earned + shareholder

level when distributed); preference could reduce the impact of inefficiencies created by this “classical system”;

Resp: only valid if premises are valid – but no consensus on degree of inefficiency created by classical system; e.g. when using borrowed funds or retained earnings to make an investment, no economic distortion created by 2 levels of tax; only problem is w/ corp raising equity funds through a new issue of stock, but this can be fixed by a preference for new issues of stock;

Distinction btw capital gain and capital loss?

- S.39(1) ITA: capital gain is a gain from the disposition of a property that is not taxed as ordinary income, while capital loss is a loss from the disposition of property that is not taxed as an ordinary loss;

- General rule : when property is purchased for some purpose other than resale, any gain/loss on its disposition is capital gain/loss;

o Capital property vs income property:

o Depends on both 1/ nature of the property; and 2/ manner in which owner manages the property;

It relates in part to the intention of the taxpayer; E.g. buying a house to realize a profit from the property (speculator in real

estate) = income; buying a house w/ intention of renting the property = capital;

Tree & its fruit: if you bought tree w/ intention of selling the fruit, then any subsequent sale of the tree would be on account of capital (50% taxable); if you purchased the tree intending to sell it and make a quick buck, then the proceeds of the sale would be on account of income (100% taxable);

You want gain to be capital (taxable only at 50% of the value) and loss to be income (deductible at 100%);

o Determination: Period of ownership: if property has been held only for short period, it may

indicate a purchase on income account; property held for a longer period is more likely to be treated as capital;

Improvement & development: where systematic efforts are made to make properties more marketable, it may indicate a purchase on income account;

Relation$ of the transaction to the TP's ordinary business: the more similar the transaction is to TP's ordinary business, the more likely = income account;

Reasons for & nature of sale: if the sale of property is the result of an active campaign to sell it as opposed to the result of something unanticipated at the time of purchase, profits may be considered on account of income;

Frequency of similar transactions: history of buying/selling similar properties or quick turnovers may indicate the TP is carrying on a business (income);

- It raises the issue of distinction btw investment & profit-making;

Scott v. MNR [1963] SCR 223

Question 29

Who: Canadian resident corporationWhat: produces corn stuff and sells it for money (business income); business risk: price of corn might go up, no quantity available, etc.Future contracts: two parties are agreeing to sell/buy at a certain price over a certain period of time; premium to take the risk out (you have to pay for the contract in other words); in a future contract, I then HAVE to buy the corn when time 2 arrives; but I can secure an option not to buy the corn if the price locked is higher than market price – call option (chose to buy or not to buy); instead of an obligation to buy, you’ve got a right to, but premium is obviously higher too.What: premium (at time 1) – it is financial product I’m being now to ensure stuff in the future; therefore the what is a gain on a contract; but if you decide to abandon the premium b/c the market price is very low, then the money paid for the premium is lost – but now it is NOT connected to the business of buying corn and selling corn products;What: corn inventory (at time 2 in the future);Question: is the outlay of the premium on income or capital account?

The thing is: if I have a gain, I want capital account, but if I have a loss, I definitely want it to be income account;

Income Tax Act interpretation – Capital Gain vs Profit: SharesShare as investmentsShare = investment if main purpose of acquisition is to generate dividend income; when disposing of the share, it will be held on capital account; Problem: today, shares are rarely just bought for dividend income (low dividend yields); SCC interpretation in Irrigation Industries: the entering into of a transaction w/ intention of disposing of shares at a profit as soon as there was a reasonable opportunity of doing so ISN'T, by itself, sufficient to make that transaction an adventure in the nature of trade (business income);

Low/non-existent dividend yield + short holding period --> insufficient for concluding to income;

Dispositions of shares = prima facie capital account;Trading volume/length of holdingDoes the TP have characteristics of a trader in securities? Yes --> income account;

Engages in large volume of share transactions; Short holding periods;

R v Forest Lane Holdings 90 DTC 6495Companies, controlled by a securities dealer, held securities which it acquires for short period of time + w/ intent to resale as quick as possible; shares of resource companies bearing no dividends; intention of the holder = profit from rumour of takeover to make profit ---> Gains = INCOME;

R v Cull [1987] 2 FTC 63Partner in law firm acquired shares of a cie engaged in development of housing subdivisions of land held under option for the purpose of making a profit from that land. When venture became worthless, TP realized a loss on income account. If shares was initially for purpose of making profit ---> Loss = INCOME;

Administrative policySecurities transactions normally part of the business of insurance corporation ---> income account;

- Capital gain = net concept ---> capital gain = capital income + capital losses;o Capital loss: 50% deductible & only deductible against capital gains (business loss

deductible against any type of income); S.111(1)(b) :

o Capital gain: 50% taxable;- See s.38 to 55 ITA:- What about gain that arises upon the sale of a capital asset previously depreciated by TP?

o If tax depreciation = real-life economic loss in value ---> basis of depreciated property would always equal its fair market value, so no gain nor loss;

o BUT: tax depreciation FASTER than economic loss in value See s.13(1); 20(1)(a); 20(16), 39, 53, 54;

- Dividends vs capital gains?o Dividends = payments from corporation as "added bonus" for owning stock in the

corporation ---> slice of the company’s profit & the choice to distribute dividends to shareholders is a choice of how to distribute profits; but corporate profits already taxed, so is it taxed twice?

Globe and Mail: You do the math: almost $50,000 in earned dividends, $0 in tax Dividends = taxed at lower rates than interest & other income; + possibility to earn a lot

through dividends & to escape taxation b/c of tax credits – but why? Dividends = profits of a cie which has already been taxed; unfair to tax it twice by taxing

the shareholder receiving dividends; General rule: gross-up & tax-credit system ---> shareholders receive credits for the tax the

cie has already paid; how is it applied?o Gross-up: on tax return, estimate the dividend back to approximate pretax

corporate earnings;o Then, figure out how much tax TP would pay on that grossed-up amount, based on

his marginal rate; o Subtract the dividend tax credit (% of the gross-up amount) from your dividend tax

amount – this is how the tax credit works;

2.5. How should we tax?How is the authority of the State to collect tax challenged?

1. The Tax Protestors“State has no authority to tax its citizens”

R v Porisky & Gould BC (2012)P & G have this business where they give seminars and advice about how not to pay tax; they

themselves are charged w/ tax evasion by failing to report taxable income contrary to s.239(1)(d) ITA; they advise their clients to set up as “natural person” so that through this device, they wouldn’t pay tax.s.239(1)(d) ITA: Every P who has willfully, in any manner, evaded or attempted to evade compliance w/ this Act or payment of taxes imposes by this Act is guilty of an offence;ISSUE: did R & G commit tax evasion?HOLDING: Yes.R alleges that a person in the Act is not the “taxpayer” but has some kind of legal relation$ to the “taxpayer” requiring the “person” to fulfill certain obligations for the “taxpayer” (such as filling tax forms). But a person is not the taxpayer and only the taxpayer’s income is taxable.A natural person is worth his labour; since profit is considered w/o the deduction of the person’s own labour, when the value of the labour is factored in, the profit is reduced to zero, and thus the natural person has no income. He earns “private compensation”. But courts have rejected this argument multiple time.

2. Do Taxpayers have rights, too? Stark power imbalance btw taxpayer and her government (w/ unlimited resources &

exclusive right to exercise violence lawfully); Counterbalanced by giving taxpayers rights

Taxpayer Bill of Rights- Non-binding Bill; not contained in the law- “commitment to serve citizens with professionalism, courtesy, and fairness”

1. Right to pay no more no less than required by law;2. Right to service in both official language;3. Right to privacy & confidentiality;4. Right to formal review & a subsequent appeal (so that 1 is respected);5. Right to be treated professionally, courteously, and fairly;6. Right to complete, accurate, clear and timely information;7. Right not to pay income tax amounts in dispute before having impartial review;8. Right to have the law consistently applied;9. Right to lodge a service complaint & be provided w/ explanation of our findings;10. Right to have the costs of compliance taken into account when administering tax legislation;11. Right to expect us to be accountable;12. Right to relief from penalties/interest b/c of extraordinary circumstances;13. Right to expect us to publish our service standards & report annually;14. Right to expect us to warn you about questionable tax schemes in timely manner;15. Right to be represented by person of your choice;16. Right to lodge a service complaint & request a formal review w/o fear of reprisal;

Cie Alberta v Canada (2010) ABCA 226Cie produces a weekly newspaper distributed free of charge; Cie generates revenues by selling advertising to 3rd parties; SEE Magazine is the main competitor for Cie;s.19 (1) (a) & s.19 (5) (a): expense of advertising in a Canadian newspaper is deductible.The director of SEE Magazine renounced to his Canadian citizenship --- therefore, SEE is not a Canadian newspaper anymore. Notwithstanding this change of status, Canada continued to allow advertisers to deduct the expense of advertising in SEE Magazine; Cie alleges that Canada has deprived it of the competitive advantage accorded to it by the ITA, thereby causing damage to the plaintiff. SEE magazine (another def’ to the claim) is seeking application to strike the statement.ISSUE: Whether Canada owes a private law duty of care in tort to Cie, arising out of the way

Canada treated the deductibility of advertising expenses claimed by other taxpayers who are not parties to this action.HOLDING: No.Cooper v Hobart 2001 SCC 79; Holland v Saskatchewan 2008 SCC 42: recognizing a duty of care from a public entity is a matter of public policy; plus, have to show that (1) harm was reasonably foreseeable; (2) sufficient proximity btw the parties (previously recognized categories);1. Harm was foreseeable;2. But unlikely that the necessary proximity exists; no prior case establishing liability on the part of tax collectors to one group of taxpayers based on the taxes imposed on another group of taxpayers; NEGLIGENT PERFORMANCE OF STATUTORY DUTIES IS NOT ITSELF ACTIONABLE; nothing in the ITA suggests that one TP has any remedy w/ respect to the assessment of another TP;3. Policy considerations would preclude any private law duty in tort:

- The relation$ btw TP and Assessor is personal & private; privacy doesn’t foreclose action, but it matter as a policy consideration at this point of the analysis; imposing a duty on the assessor to account to one TP for the way it assessed another TP impedes on the relation$ in an unacceptable way;

- It further presupposes that CRA has no discretion and that there would only be one right answer to any income tax question; the tax assessor is require to exercise her judgment and common sense & sometimes, compromises are necessary;

3. Are there any limits on the power to tax?- From what we’ve seen, it seems that the only thing stopping the state is the ability of people

to band together and depose leaders who do not represent their collective interests;- Privacy issues: s.231(4) ITA: authorizes the CRA to require any person w/ relevant books and

records to furnish them to the Service for inspection of a given TP, once certain procedural measures are met;

o Inconsistent w/ constitutional guarantee against search & seizure w/o cause? Del Zotto v Canada (1999) 1 SCR 3: inspection of the CRA doesn’t infringe on

s.7 and 8 of the Charter;- Question: how far TP may go to shield themselves from tax simply by creatively arranging

their affairs to avoid taxes that would otherwise apply?

Duke of Westminster v. Commissioners of Inland Revenue (1936) CA (House of Lords) 1 (UK)

DofW pays some kind of amount to retired servants that were agreed on while they were still working for him. He is trying to pass them as some kind of annual payment which he could deduct from his income. ISSUE: are they payments salary or annual payment? Should the Court respect the contractual will of the parties or can it intervenes?HOLDING: Annual payment, in conformity w/ the contract laid out btw the parties;Doctrine of “substance of the matter”: court may ignore the legal position taken by parties and regard what is called the substance of the matter. Lord Tomlin: every man is entitled to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. The doctrine of the substance seems like an attempt to make a man pay notwithstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable. When construing language given by the parties, one must look at the surrounding circumstances of the agreement. Good faith is necessary however – but bad faith is no suggested here. The conclusion must be that each annuitant is entitled to an annuity which is liable to deduction of

income tax by the payer;Lord Russell: if the payment of these sums is payment of salary or wages, then DofW is not entitled to exclude the amounts paid in ascertaining his total income for sur-tax purposes; but if the payment is annual payment, then he is entitled to exclude the amounts paid in ascertaining such total income.Looking at the substance of the payments, Commissioners assessed payments as wages.In disfavor of this doctrine: the subject is to be taxed if, in accordance w/ a Court’s view, the Court thinks that the case falls w/in the contemplation or spirit of the statute. However, the subject is not taxable by inference or by analogy, but only by the plain words of a statute applicable to the facts & circumstances of his case. We should not accept that deeds be brushed aside and that complete disregards is paid to the contract passed btw parties.

FOR the deductions

AGAINST the deductions: