Turning back time

RETROACTIVE LEGISLATION CAN BE JUSTIFIED IN EXCEPTIONAL CIRCUMSTANCES, BUT TAXPAYERS DON'T ALWAYS NEED TO AGREE

For centuries taxes have fuelled the activities of governments worldwide. Over time, countries have refined their rules for imposing taxes. For example, Canadian federal income tax was introduced in 1917 in the Income War Tax Act, a 10-page document that provided a simple framework for the taxation of income. Canadian taxpayers responded by challenging the applicability of provisions or planning their activities to circumvent the legislation; in turn, Parliament amended the legislation. Like opponents in a chess game, taxpayers move by implementing new planning activities and Parliament moves by amending the legislation. Both sides test their position in the courts. Over the years, this chess match has produced an enormous spidcrweb of rules here and in other developed countries.

Compared with the Income lax Act, the goods and services tax legislation is still in its infancy. Although it began as a much more substantial document than the original Income Tax Act, it has since become much more complex. Its spiderweb provides a framework for taxpayers to plan their affairs.

While tax "certainty" is a fundamental principle of taxation, Parliament has the ability to alter that framework. Changes could have retroactive consequences, which may range from the date the amendment is announced to years in the past. As with any legislation, there is also a time lag between when the amendments are announced and when they have the force of law. Here we will examine the use of retroactive legislation and consider the government's administrative practices where legislation is not yet in force. While GST legislation is the focal point, the same considerations arise with respect to other taxing statutes.

Retroactive amendments

In the early 1990s, the government of Canada lost an income tax case relating to the calculation of the resource allowance. The estimated cost in refunds and interest exceeded $ 1 billion. Not surprisingly, the auditor general reviewed this issue, as did the Commons Standing Committee on Public Accounts. In response, the Department of Finance provided guidelines for the introduction of retroactive legislation.

As a starting point, Finance indicated that retroactive tax changes should only be made in exceptional situations. It cited tax certainty as a fundamental principle of taxation, which would be undermined by retroactive legislation. The department listed several factors that should be taken into consideration when contemplating retroactive legislation. In summary, the amendments should:

* reflect a long-standing well-known interpretation of the law by the Department of National Revenue (now known as the Canada Revenue Agency);

* reflect a policy that is clear from the relevant provisions that is well known and understood by taxpayers;

* be intended to prevent a windfall benefit to certain taxpayers;

* be necessary to preserve the stability of the government's revenue base;

* correct ambiguous or deficient provisions that were not in accordance with the object of the act.

Finance indicated that the first four factors should not be considered in isolation, while the fifth factor should be considered independently. However, "the presence of one or more of the following factors would not necessarily lead the government to propose retroactive legislation."

While these criteria narrow the range of circumstances in which retroactive legislation is permitted, taxpayers have questioned whether Finance always follows its own rules. For example, in 1996 the federal government proposed amendments to the GST legislation, which expressly made GST payable on the management and administrative fees of mutual fund trusts. The legislation was ultimately passed and was deemed to be effective December 31, 1990 (retroactive to the introduction of the GST). However, the amendment did not apply to supplies on which the supplier did not charge or collect GST on or before December 7, 1994.

Approximately a month before the amending provisions were announced taxpayers had launched an appeal to the Tax Court of Canada - CI Mutual Funds Inc. etalv. The Queen [1999] 2836 ETC (TCC), aff'd [1997] 2942 ETC (FCA) - claiming a refund of GST paid on management and administrative fees. The taxpayers argued that the amended legislation should not apply retroactively to interfere with vested rights. (The provision did not come into force until after the appeal was argued at the tax court. After the provision was enacted, counsel appeared to provide additional submissions before the decision was rendered.) Both the tax court and the Federal Court of Appeal held that the wording was sufficiently clear to apply retroactively. In essence, Parliament had the authority to enact such retroactive provisions.

Tax practitioners were also critical of the timing of the application of this provision (see Louise Summerhill, "GST Reform" [September 1996] Tax Profile, and Cy Fien, "Retroactive Legislation," 1996 Canadian Tax Foundation Conference Report). The amendment was retroactive to the introduction of the GST, however the industry was only given notice in a December 1994 announcement. If a manager did not charge or collect GST prior to December 7, 1994, the provision did not apply to make those supplies taxable. However, where tax was charged and collected prior to December 7, 1994, GST applied. This was problematic, as many fund managers had charged GST prior to December 7, 1994, but the funds sub-sequently claimed a refund. The legislation was enacted notwithstanding these criticisms.

Retroactive legislation was also announced in the February 18, 2003 budget in response to Des Ch�nes (Commission Scolaire) v. The Queen [2002] GSTC 11 (FCA). In that case, a municipality argued it received money from the provincial goveminent to provide school bus services in the context of a commercial activity. The Federal Court of Appeal agreed, which meant the municipality was entitled to recover all the GST it had paid on related expenses (rather than just a percentage thereof). The federal government responded with amending provisions, which clearly provided that the services are exempt (and therefore municipalities would not be entitled to recover all of the GST paid on their inputs). These amendments were retroactive to the introduction of the GST, except that the amendments did not affect cases decided by the Federal Court of Appeal prior to the announcement of the legislation.

At the same time, retroactive legislation was announced to provide that the supply of public services to municipal residents is exempt, whether provided by the municipality or a contractor. This amendment was also in response to a court decision, Charlesbourg (Town of) v. Quebec (Deputy Minister of Revenue) [1999] RDFQ 187,afPd Quebec CA February 18, 2002, in this case a Quebec Court of Appeal decision. This amendment is effective from the introduction of the GST.

Industry and tax practitioners were critical of the 2003 retroactive amendments and argued that the amendments were contrary to Finance's stated policy. Notwithstanding the criticisms, Finance took the position that the amendments did not offend the criteria discussed above. As a result, the amendments were enacted on a retroactive basis.

Parliament's ability to enact retroactive legislation effectively provides it with an extra move in the chess game. Since the courts have accepted Parliament's ability to enact retroactive legislation, litigation is not a viable alternative. At the same time, taxpayers' only real recourse is to make submissions to Finance regarding the appropriateness of retroactive amendments. While such submissions have met with little success it remains important that the government be held to its own guidelines.

Administrative practices

Whether legislation is intended to take effect from announcement or to have retroactive force, it is of no effect until enacted. Since there is generally a time lag between announcement and enactment, taxpayers can be left wondering how to deal with transactions in the interim.

The Canada Revenue Agency has provided some guidance in this regard. For example, it has ruled on the application of a new GST taxing provision. A rulings letter indicated that Revenue will not assess based on proposed amendments until enacted. However, given the retroactive application of the amendments, taxpayer compliance is encouraged as of the effective date. The GST legislation specifically provides that interest is calculated retroactively to the effective date of an amendment. However, penalties will not be applied retroactively.

The guidance provided with respect to relieving provisions is less helpful. For example, another rulings letter provides as follows:

* If the registrant decides not to collect and remit the GST/HST, and should proposed section 7.2 not come into force, the registrant would be liable for the GST/ HST collectible on those supplies, and penalties and interest.

* If the registrant decides to collect and remit the GST/HST, and should proposed section 7.2 later come into force, the amounts collected as GST/HST can be refunded to the recipients of the supplies in accordance with section 232 of the ETA. Alternatively, the recipients could apply for a rebate under section 261 of the ETA.

Given the interest consequences, taxpayers should immediately act on new taxing provisions. However, they do so at their peril with new relieving provisions.

Conclusion

The government has acknowledged that retroactive legislation can only be justified in exceptional circumstances. As we have seen, the taxpayer side does not always agree that the background to a particular amendment warrants such treatment. Taxpayers have limited ability to directly alter the rules of the tax chess game. As a result, they must play the game within the current framework. That said, taxpayers can test the boundaries of the chessboard. Where their moves prompt retroactive legislation, taxpayers should analyse whether the circumstances fit the government's criteria. In the end, taxpayers must understand the interest and penalty consequences arising from disregarding proposed amendments.

We can anticipate that the spiderweb of tax rules will continue to grow. Retroactive amendments alter the field, but may provide new tax planning opportunities. We await the next move.

[Author Affiliation]

Dona Gilbertson, LLB, MBA, is senior manager with Ernst & Young LLP in Toronto

Technical editor: Trent Henry, CA, leader of international tax services, Ernst &Young LLP