PUB2-313 Prof. Allison Christians Fall 2015

Taxation

PUB2-313
Prof. Allison Christians
Fall 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?
• 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.
• 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?
• 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.
• 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 consensus

Indirect 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 lawmaking

Implementation follows a different logic than creation of tax law.

2. Structure

2.1. Who should we tax?

What is the base that we tax?

2.1.1. Humans

ITA
s.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);

ITA
s.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
Question
1/ $44,701 *15% = $6705.15
$44,700 * 22% = $9824
$10 599 * 26% = $2755.74
Total = $19 294.8
2/ 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. Entities

Entities 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 – Partnership

Def. /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).

ITA
s.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
Question
4/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 – Corporations

Def. /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.

ITA
s.89 / Corporation / (1) Def. /Can corp./ = currently resident in Can & either incorporated in Can or been resident since 1971; taxable unless 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 – Trust

Def. /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.

ITA
s.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)

Question
5/ 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, Duff

Haig/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 -- Haigdef/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, Simonsdef/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 + Δvalue of these objects of consumption?)

B) Statutory framework

TA
s.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).

TA
s.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 framework

In 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 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):

• TP has no enforceable claim to payment;
• No organized effort to receive payment;
• Not sought/solicited by TP;
• No recurrence;
• Payor isn’t customary source of income for TP;
• 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?