Direct Vs. Indirect Taxes (John Stewart Mill)

Table of Contents

Chapter 1: Introduction

What Is a Tax?

Direct vs. Indirect Taxes (John Stewart Mill)

Constitutionality of Taxation

Taxation Rate Regimes

Evaluating Taxes and Tax Regimes

Unit 2

Test for residency

Tax Base

What Is Income

Unit 3

The Income Tax Act

Secondary source of Canadian Income Tax Law

Provincial Tax Legislation

Tax Courts

Amending the Income Tax Act

Canada Revenue Agency Publications

Unit #4

The Administration of Income Tax Law

Process of Filing Taxes

Notice of Objection

Settlements

Unit #5: Employment Income

Section 5: Salary, Wages And other remuneration received by the Taxpayer

Section 6: What is characterized as employment Income

Section 7: Taxation of Employee Stock Options

Section 8: Employment Deductions

Characterization of Employment vs. Business relationship

Incorporated Employees

Introduction to Employment Benefits

General Approach to the Inclusion (and Taxation) of Employment Benefits

Characterization as an Employment Benefit

Chapter 1: Introduction

What Is a Tax?

Dictionary def’n =A contribution to State revenue, compulsorily levelled on people, businesses, property, income, commodities, transactions, etc.

Textbook = a contribution to government revenue compulsorily levied on individuals, property or businesses

Sprysak definition: payment of money w/ no immediate or directly linkable good or service in return

NB: if there is a direct good or service in return this constitutes one of the following: fee/exchange/sale

SCC Def’n of Tax Lawson v Interior Fruit and Vegetable Committee of Direction

A tax is a charge which is:

(1)Enforceable by law (compulsory)

(2)Imposed under the authority of the legislative branch of government (no taxation w/out representation)

(3)Imposed by a public body (allows legislature to delegate powers to another public body)

(4)Imposed for a public purpose

Lawson v Interior Tree Fruit and Vegetable Committee of Direction
Facts: BC fruit rancher did not want to have levies and licencing fees imposed on him by the BC government. Challenged legislation as ultra vires. SCC granted his appeal and discussed what is a tax.
Ratio: Set out 4 requirement of a Tax (enforceability, authority of legislature, public body, public purpose)

IN ADDITION to the LAWSON Criteria: SCC looks at whether the charge more closely resembles a fee

Fee = exchange, and the amount relates to the cost to the government for providing that good/service

Tax = Government takes money from the person based on certain indicators (e.g. income) which may not directly relate to government expenditures on that good/service

Two Requirements for a fee (RE Eurig)

1.Charged with respect to a good/service that is being provided to you

2.Connection between the amount charged and the cost imposed on government for providing good/service

Re Eurig Estate, [1998] 2 S.C.R. 565
Facts: ON enacted a probate regime whereby for a fee, the provincial courts would examine the will and if it complied with the relevant law, provide letters of probate to the executors, which they could then take to third parties (who would have to comply with the terms of the will). Executive branch did this under authority of the Administration of Justice Act, which delegated to the Executive the power to make regulations regarding the payment of “fees” (but made not explicit mention of delegating the power to create “taxes”).
Reasoning:Court considered Lawson factors and considered the fact that the fees:

Were on a sliding/increasing scale,
This scale depended upon (or were tied to) the value of the deceased’s estate, rather than the costs incurred by the courts to grant probate, and
These graduated levies were intended to generate a surplus for the province, rather than simply cover the costs of providing this service (see paras 20-23)

Held: Probate system was actually a tax (direct tax)

Why Should we Care what a tax is

Two constitutional reasons:

(1)Section 91/92 of the Constitution Act Respective taxation powers

(2)Section 53 & 90 Constitution  for a tax to be valid it must originate in legislature (“no taxation w/out representation)

Direct vs. Indirect Taxes (John Stewart Mill)

A direct tax is one that is demanded from the very person who it is intended or desired should pay it; whereas [charge the person who gets direct benefit from it]

Example: PST, Income Tax

An indirect tax is one that is demanded from one person in the expectation and with the intention that he shall indemnify himself at the expense of another (“paying off”) [tax one individual with expectation that will transfer liability to someone else]

Example: Liquor tax/fuel tax

TEST (per Bank of Toronto v Lambe): court will consider “the general tendencies of the tax and common understanding of men as to those tendencies”.

NB: this distinction is important because the Constitution incorporates these definitions in allocating power[provinces can only implement direct taxation regimes]

Alternative Classifications of Taxation

Type of Tax / Taxation Type / Trigger / Advantages/Disadvantages
Head Tax / Less Complex / Head (a person) / A: simple to understand/administer, efficient, neutral, fair (same burden on every person)
D: regressive, unfair (same burden on every person), inefficient.
Consumption / Consumption / A: Fairly simple (at least in theory), ties taxation to benefit/use, encourages savings/investment
D: May tax poorer people disproportionately, discourages spending, may not accurately reflect “ability to pay”
Income / More Complex / Income (Consumption + changes in wealth) / A: Better ties taxation to ability to pay taxes, better utilization of revenue base
D: Discourages income providing activities, more expensive to administer, discourages savings as compared to a consumption tax, chases away the wealthy

Constitutionality of Taxation

(A)Federal Government – s.91(3)

Power to raise money by any mode or system of taxation BUT
Feds must have jurisdiction (some connection to Canada) – 2 requirements

(a)Connection between the country and the person (residence, citizenship, domicile) OR

(b)Source of income (regardless of where living, income can be traced within our borders)

(B)Provincial Government – s. 92(2)

power of “direct taxation within the province in order to the raising of a revenue for provincial purposes”

(C)No Taxation w/out representation – Section 53, 54, 90 of Constitution Act

In order for tax to be valid it must originate in the legislature (parliament or provincial leg.)
Can be delegated to a public body (such as Executive) BUT must be done explicitly and intentionally (Eurig Estate)
This aspect of taxation is important for democratic reasons (don’t like the tax vote em out) & prevents the senate from initiating their own taxation regime

(D)S. 121 provides that all Articles of the Growth, Produce, or Manufacture of any one of the Provinces shall, from and after the Union, be admitted free into each of the other Provinces.Prevents one province from taxing another province

(E)S. 125 no lands or property belonging to Canada or any province shall be liable to taxation.Prevents the federal government from taxing the provinces, and vice versa

Bank of Toronto v Lambe (1887) - Direct vs. Indirect Taxation
Facts/Issue: Quebec decided to tax any provincial institute that worked within its provincial boundaries. Bank operated primarily in upper Canada but had a few branches in Quebec. Quebec said we want to impose a tax on the entire bank (not just those in Quebec). This was going to be a significant charge to the bank of Canada, so they challenged it that Quebec imposing an unconstitutional indirect tax.
Decision: Tax Constitutional
Ratio: To determine whether a tax is “direct” or “indirect”, the court will consider “the general tendencies of the tax and common understanding of men as to those tendencies”  even though the business recovers their costs from the consumer does NOT mean that every corporate tax is indirect  a tax can have indirect effects and still be a direct tax

Intention of the Quebec legislature and the general tendencies of the tax was that the banks were intended to pay and ultimately bear the burden of the tax.
BUT if dealing w/ a commodity or export tax (tax added to the gross supply chain) and the legislature wants to impose the tax in the supply chain and this tax is passed down (from manufactuer to consumer), then this is indirect as the legislature will anticipate that the tax is pass down

For example in PST as direct tax, there is one tax which is triggered when a consumer purchases something subject to PST. Retailer is acting as the agent for the government. The retailer does not pay the tax. There is not a case where the retailer pays it then recoups from individual consumer.

NB: There is a fundamental difference in “economic tendancy” of the owner to try and shift the incidence of the tax and the passing on of the tax. When a tax is passed down the supply chain if tax is“ related to a unit of the commodity or its price, imposed when the commodity is in the court of being manufactured or marketed than the tax clings as a burden to the unit of transaction presented to the market”) [Canadian Pacific Railway v Sask]  if commodity type tax, which is levied early in the chain = indirect tax

Kingstreet Investments Ltd. v. New Brunswick,[2007] 1 S.C.R. 3.
Ratio: The surcharge placed on liquor purchase for resale was unconstitutional to the province because indirect tax.
Re Eurig
Majority decision (Major): If the Administration of Justice Act had explicitly delegated the power to create taxes by legislation to the Executive, then such taxes would pass the section 53 constitutional requirement; however, as the legislation only delegated the power to impose fees, the probate regime was constitutionally invalid (para 36)
Dissent (Bastarache): the only purpose of section 53 is to prevent the Senate from introducing and enacting tax legislation.
Given this, we aren’t too bothered by the fact that the Administration of Justice Act did not specifically refer to (and delegate) the taxation power. The delegation set out in section 5 to impose fees was legally sufficient to include the probate taxes – therefore the taxes actually imposed are constitutional and legal.

Types of Taxes

Provincial Tax / Federal Tax
21.8% of total revenues comes from income taxes
GST 11%
Property tax 16% / 60% of its total revenues are derived from income tax
75% of its tax revenues are derived from income taxes

76% of income tax revenues are derived from personal income taxes

GST raises 12% of total revenues (under 15% of tax revenues)

Solution for Alberta Taxation Issues

(1)CD Howe Institute 8% solition: reduce personal income tax to 8% and add 3% sales tax to GST

Solution to reduce rapidly growing expenses and lead to greater saving, investment and result in less volatile gov’t revenues
Support HST b/c compared to income taxes, consumption-based taxes are a less economically distortive way of raising gov’t revenue (increase gov’t revenue, less volatile, simple to administer)
Although this change would be revenue neutral it would put more emphasis on a less volatile tax base than it present is in relying on royalty revenues and would spur economic growth (lowering income taxes effects tax payers behaviors and would boost taxable incomes for a tax revenue gain)
Offer a large tax credit to cancel out the regressive taxation impact of the sales tax
Advantages: encourages foreign investment (corporate tax remains low)
Disadvantage: decrease consumption, black market sales

(2)Parkland Institute increase corporate and personal income tax rates

Says AB is dealing w/ fiscal shortfall from over-reliance on natural resource royalties (volatile and unsustainable) in funding core services (healthcare, education, social services, public infrastructure) and NOT overspending.
This solution would bring in more money and help stabilize provincial revenues.
Even in making these changes could still be the country’s lowest-tax jurisdiction and says would be more instep w/ Albertan’s beliefs (those who earn more should bare more of the tax burden)
Disadvantages: discourage foreign investment

Taxation Rate Regimes

Three different taxation regimes:

1)Proportional (flat tax) rate of taxation does not change as income changes {Alberta}

2)Progressive  taxpayers tax rate increases w/ income [all provinces except AB]

Vertical equity satisfied

3)Regressive  taxpayers pay tax at a lower rate as their income increases

Can still have vertical equity in this regime  they still pay more tax, just pay a lower tax rate

NB: if you combine a progressive rate regime (Federal) with a proportionate tax regime (Alberta you get a Progressive Rate Regime

Horizontal vs. Vertical Equity

Vertical Equity = If you have a different amount of income, then you should pay a different amount of tax. More specifically, the person with the higher income should pay more tax than the person with the lower income.

In Canada we have vertical equity but NO horizontal equity, as different types of income are taxed differently

Horizontal equity= individuals w/ similar income and assets should pay the same amount in taxes no matter the difference in situation between the two people

Canada often violates this – because capital gains are taxed less than employment income
In Canada, we distinguish between different types of income and DO NOT have horizontal equity
5 types of income under the Income Tax Act
Employment income
Property/investment income
Business income
Other (eg. receipts from a pension plan)
Capital gains
Each source of income has separate rules for calculating the tax on that income

Because of this there are advantages to having income counted as one form or another.

EX. Canada often violates Horizontal Equity principal b/c an individual who does not work but makes $50,000 of capital gain will pay less tax than someone who works and makes $50,000 in employment income.

Terminology:

Marginal Tax Rate: the rate at which incremental income will be taxed.

Every additional dollar will be taxed at that

Average Tax Rate: this is calculated by taking total taxes payable and dividing it by total taxable income.

Equation: Avg Tax Rate = Total Taxes Payable/Total Taxable Income
In a progressive system – marginal tax rate will always be higher than average tax rate

Refund Calculation: 10,000 taxable income, put a 1000 into RRSP  1000/last tax rate = $260  refund calculation

History of Income Taxes in Canada

Canada has the Canada Revenue Agency administer and collect not only federal, but provincial income taxes. Province delegates their taxation power to the municipality, and delegate power to levy tax primarily through property tax.

This is accomplished through “tax collection agreements” – which generally require the provinces to use the Income Tax Act’s calculation of “taxable income”

Two Exceptions to system:

1)Quebec  own income tax legislation for corporations and trusts

2)Alberta  corporate income tax

Evaluating Taxes and Tax Regimes

Three ways governments evaluate taxation regimes:

Revenue Generation:

Enact to generate revenue (car taxes, luxury taxes, sin taxes)
Evaluate the taxes effectiveness by how well it achieves this goal
Caution: to high a tax causes people to leave the province/country, decrease consumption
May levy a tax to decrease consumption

Equation: Revenue = Tax base [income] x tax rate

To increase revenue can either broaden the tax base or increase the tax rat e
General trend has been to lower tax rates
Non-taxable bases: income in RSP and RESP is not subject to tax while it is in the plan, tax free savings account, gifts and inheritances, lottery winnings, gambling, scholorships, capital gains
Tax free savings account

Efficiency:

Two components:

1)Look at how imposition of how tax influences tax payers behaviour

An efficient tax is one that does not influence behaviour – let market govern
Head tax does not influence
Consumption tax will influence
EXCEPTION: The “income effect of taxation” = To the extent that the imposition of a tax provokes people to work more in order to pay for that tax, the tax is inefficient but it is a good inefficiency. But, there is also the “substitution effect” where a tax is implemented or increased and a person changes to non-taxable activities.

2)Look at costs of administration (cost to comply w/ tax and administer and ensure compliance)  common measure

If easy to evade tax, it may not be efficient

Fairness or Equity:

Basic Principle  if tax is unfair people will not comply

How do we determine what is fair: Two governing philosophies

(1)Ability to pay principal

Amount of tax should directly relate to persons ability to pay  in Canada equate this to income
Does not account for how the person is actually living
Difficult to determine what should be included in a persons income (inheritances, dependants etc)

(2)Standard of Living Principle:

If you can afford more or consume more you should pay more

Unit 2

Five Elements to Canada’s Income Tax Regime – Section 2(1)

(1)A tax unit (i.e. taxpayer), who is the subject of taxation, (who are we going to tax?)

(2)A tax base (i.e. income), on which the tax is assessed, (what are we going to tax?)

(3)A taxation year (aka “accounting period”), which is the period of time over which income and the associated tax liability (if any) is calculated, [time period over which tax calculated – most countries tax over a taxation year – could have a system where taxes calculated over a persons lifetime]

(4)A taxation rate regime (aka “a structure of tax rates”), which is applied to income to calculate the taxpayer’s tax liability, and [mechanical calculation]

(5)Tax credits, which reduce the taxpayer’s tax liability calculated above. [tax credits]

(6)PLUS additional element of tax expenditures: Expenditures (can be in the form of a credit, deduction or exemption), which are direct spending by the gov’t contained and administered though the ITA and allows the gov’t to use the existing tax regime as a way of providing benefits to their members.

Section 2(1): An income tax shall be paid, as required by the Act, on the taxable income for each taxation year of every person resident in Canada at any time in the year.