A Canadian income tax assessment or GST/HST assessment triggers an immediate payment obligation and is subject to collection action by the Canada Revenue Agency (CRA), notwithstanding that the taxpayer is formally disputing the assessed amounts. It is important for taxpayers facing large Canadian tax assessments or negotiating indemnification provisions in respect to Canadian taxes to understand the operation of the collection provisions and what payment arrangements may be available.
QUESTION: What are the ground rules on payment arrangements for unpaid assessments of Canadian income tax or GST/HST?
Answer: The basic ground rule is that an assessment of income tax or GST/HST creates a debt that is immediately payable to the Canadian government. Collection action may be suspended if the taxpayer posts security that is acceptable to the CRA, but the rules vary as to when the CRA must accept security.
How Much of the Assessment Is Subject to Collection Action?
There are significant differences in the collection provisions applicable for Canadian federal income tax purposes and GST/HST purposes, although the regimes are substantially similar.
For Canadian income tax purposes, subject to reaching an arrangement with the CRA to post acceptable security, a “large corporation” (i.e., a corporation with more than $10 million of capital) must pay fifty percent of the amount assessed as owed by it in respect to corporate income tax, interest, and penalties that are in dispute under a valid notice of objection and one hundred percent of any amount assessed as owing in respect to the nonresident withholding tax that are subject to an objection.
For GST/HST purposes, subject to reaching an arrangement with the CRA to post acceptable security, the taxpayer must pay one hundred percent of any amount assessed by CRA as owed by the taxpayer as GST/HST.
When Can a Taxpayer Post Security?
The rules with respect to accepting security apply only to amounts that are being disputed under a notice of objection. The Income Tax Act (ITA) requires the CRA to agree to “acceptable security” in lieu of payment of an assessment of nonresident withholding tax. Similarly, the Excise Tax Act requires the CRA to agree to “acceptable security” in lieu of payment of an assessment of GST/HST. However, the CRA has discretion as to whether to agree to accept security for an unpaid assessment of corporate income tax, interest, and penalties. CRA’s published position under IC 71–17R5 is that CRA will accept security for corporate income tax only in respect to amounts that are covered under a notice of objection and a request for competent authority relief under a tax treaty. This would pretty well limit the availability of security arrangements for corporate income tax to transfer pricing adjustments and similar assessments involving treaty countries. Note, however, that this policy does not apply in respect to posting security in respect to an assessment of nonresident withholding tax.
What is Acceptable Security?
Generally speaking, CRA requires a letter of credit issued by a domestic Canadian bank or a branch of a foreign bank that is authorized to carry on a banking business in Canada. The exact wording of the letter of credit is agreed to, from time to time, by CRA with the Canadian Bankers Association and therefore subject to change. The wording is extremely favorable to the CRA. No additions and substitutions are allowed. CRA requires that the amount of the letter of credit be equal to the outstanding taxes and interest and penalties assessed at the time the letter is issued, plus an estimate of twelve months’ additional interest.
What are Advantages and Disadvantages of Posting Security?
There is a potential cash flow advantage to posting security in lieu of paying the assessed amounts, as the taxpayer will not need to use its working capital or borrow funds to meet its obligation to pay the assessment.
Taxpayers may also wish to consider the application of arrears interest and refund interest to assess amounts that are in dispute. Currently, under Income Tax Regulation 4301, arrears interest is payable by a corporation at five percent per annum (i.e., the Government of Canada Treasury Bill Rate plus four hundred basis points) compounded daily and is not deductible in computing income for Canadian income tax purposes. Refund interest, on the other hand, is payable by a corporation at the Canadian Treasury Bill Rate—currently one percent—and is required to be included in the taxpayer’s income for Canadian income tax purposes in the year the interest is received. A taxpayer that is confident that an adjustment will be reversed and that it can earn more than the Treasury Bill Rate plus the fee payable for the letter of credit may wish to post security so that it can continue to use the disputed amounts until its appeal from the assessment has been decided. Similar reasoning would favor posting a letter of credit if the taxpayer is confident that it can earn more than the arrears interest rate plus the letter of credit fee.
Posting security also avoids the complexity of recovering tax refunds and the fund interest from the CRA. It may also be desirable to post security when an amount in dispute is subject to a tax indemnification provision. The “indemnifying party” may also prefer to post security instead of paying the disputed amount to avoid the complexity of recovering any refunded amounts from the indemnified party. One of the principal potential advantages of posting security is that the taxpayer may continue to use the disputed amounts in its business.
On the other hand, payment of the assessed amounts in dispute will stop the accrual of arrears interest for future periods. There is also some additional effort, and of course the letter of credit fee, involved in posting a letter of credit. This will include internal management discussions as well as discussions with CRA Collections and the issuing bank.
What Is the Best Approach in Dealing With CRA Collections?
It is best to be proactive with CRA Collections and to contact this agency as soon as possible after an assessment has been issued to propose an arrangement to pay or secure the taxes. The initial contact can be made by telephone.
Collections is a separate unit from CRA Audit and generally has no ability to adjust the assessment. When there are obvious errors in the assessment that CRA Audit has acknowledged, it is generally advisable to enlist the auditor to explain what corrective action will be taken.
How Do Canadian Payment Rules Affect Tax Indemnification Provisions?
The wording of the tax indemnification provision is key. Tax indemnification provisions in a share purchase agreement frequently provide for indemnification by the vendor for preclosing taxes only after liability for such taxes has been “finally determined.” This could refer to the issuance of an assessment by the CRA, as the assessed amount is deemed to be a debt owing by the taxpayer at that time. It is strongly arguable, however, that a taxpayer’s liability for an assessment will not be finally determined until an agreement fixing the taxpayer’s liability has been reached with the CRA or all rights of appeal from the assessment have been exhausted or have expired.
Because assessed amounts are subject to collection action by the CRA when the assessment is issued, this last interpretation of “finally determined” could require the taxpayer to pay or post security for the assessed tax, interest, and penalty amounts until its liability has been finally determined, which could be several years after the assessments have been issued. The burden of funding the payment of taxes for prior years could potentially trigger default by a taxpayer under its credit agreements. A share purchaser who seeks to rely upon a tax indemnification provision to protect it against an assessment for taxes in respect to preclosing periods may wish to ensure that the vendor is obligated to fund, through payment or posting acceptable security, any amounts that are assessed as tax, interest, or penalty in respect to the preclosing period.
Blake Murray is a partner in the Toronto office of Osler, Hoskin & Harcourt LLP.