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The Queen v Colitto – Clarity to Directors’ Liability & Non-Arm’s Length Transfers pursuant to the Income Tax Act (Subsections 227.1(1) & 160(1)) – Canadian Tax Lawyer Analysis

Introduction –Anti-Avoidance Rules (Subsections 160(1) & 227.1(1))

Canada’s federal Income Tax Act contains anti-avoidance provisions that are designed to protect the collection of taxes by the Minister of National Revenue (the “Minister”). Two of these provisions are: subsection 160(1) and 227.1(1).

Subsection 227.1(1) renders a corporate director jointly and severally liable with his or her corporation for failure to “deduct, withhold, remit or pay” a source amount required under Canada’s Tax Act. Likewise, where a tax debtor transfers property to a related person in order to escape his or her tax liability, subsection 160(1) renders the other person (the property transferee) liable for the tax debt of the transferor.

The Queen v Colitto is a successful appeal by the CRA from a decision of the Tax Court of Canada, which allowed a taxpayer’s appeals from reassessments pursuant to sections 160 and 227.1 of the Income Tax Act. This case illustrates that understanding the legislative requirements in these two provisions and how they interact with each other is a complex area of law that requires detailed analysis and advice from an experienced Canadian tax lawyer.

The Queen v Colitto – The Facts

Domenic Colitto (Mr. Colitto) is a Director and Shareholder of Core Precision Technologies Ltd. (Precision). Between February and August 2008 Precision failed to remit payroll source deductions to the Minister. As director of Precision, Mr. Colitto was alleged to have failed to exercise due diligence to prevent Precision’s failure to remit the required source deduction.

On May 2, 2008, Mr. Colitto transferred to his spouse, Caroline Colitto (Ms. Colitto), 50% interest in two real properties and in return he received $2 consideration for each property interest.

On October 10, 2008, the Minister issued a Notice of Assessment to Precision for the unremitted source deductions. Precision did not object to the Minister’s assessment. On August 6, 2009, a certification of Precision’s tax debt was registered in the Federal Court pursuant to section 223 of Canada’s tax act. A direction dated November 23, 2010 to enforce the writ with Federal Court was made to the Sheriff’s office. Precision’s tax debt was executed and returned unsatisfactory on January 4, 2011.

On March 28, 2011, the Minister issued a Notice of Assessment to Mr. Colitto pursuant to section

227.1 of the Income Tax Act with respect to Precision’s debt. Mr. Domenic did not object to the

Minister’s assessment.

On January 13, 2016, the Minister assessed the Respondent Ms. Colitto pursuant to section 160 of

the Income Tax Act with respect to the property interests transferred to her by her husband. Ms. Colitto filed an objection dated April 12, 2016 and subsequently appealed to the Tax Court of Canada.

The Tax Court of Canada allowed Ms. Colitto’s appeal on the grounds that Mr. Colitto’s director liability, pursuant to subsection 227.1(1), did not arise until 2011 and as a result the transfers of the two properties were not caught by subsection 160(1) of Canada’s tax act.

The Tax Court Decision and Analysis:

The issue before the Tax Court of Canada was whether Mr. Colitto was a tax debtor pursuant to subsection 227.1(1) “in or in respect of the taxation years” when he transferred the property interests to Ms. Colitto.

As previously mentioned, where certain conditions are met, subsection 160(1) renders a person jointly and severally liable where he or she receives property from his or her spouse (or another person) for less than the fair market value of the property and where the transferor is a tax debtor. Likewise, a director’s liability assessment under subsection 227.1(1) of Canada’s tax act renders him or her together with the corporation “jointly and severally, or solidarily, liable” for its failure to remit required source deduction to the CRA.

The Tax Court of Canada explained that a director’s liability under subsection 227.1(1) does not arise unless a certificate for the corporation’s debt is registered in the Federal Court and that corporation’s debt returns unexecuted and unsatisfied by the Sheriff. The Tax Court of Canada pointed to the fact that while the property interests were transferred on May 2, 2008, Precision’s debt returned unexecuted and unsatisfied on January 4, 2011. The Tax Court of Canada held that Parliament did not intend the liability under subsection 227.1(1) to be “absolute” and therefore Parliament “prescribed limits to” the Minister’s collection power under this provision. The Tax Court of Canada explained that if Parliament intended for a directors’ liability to arise under subsection 227.1 prior to meeting the statutory conditions it could have used such language.

In conclusion, the Tax Court of Canada held that the 2008 transfer of property interests from Mr. Colitto to the Respondent were not caught by subsection 160(1) of the Income Tax Act because Mr. Domenic Colitto’s director’s liability under subsection 227.1(1) was not crystalized until 2011. As a result, the Tax Court of Canada allowed Ms. Colitto’s appeal.

Consideration of the Issues by the Federal Court of Appeal:

The issue before the Federal Court of Appeal was whether Mr. Colitto directors’ liability under section 227.1 was analogous to his 2008 taxation year, within the meaning of subsection 160(1) of the Income Tax Act. The Federal Court of Appeal held that this issue required subsection 227.1 of Canada’s tax act to be interpreted using a “textual, contextual and purposive analysis to find a meaning that is harmonious with the Act as a whole”, as per the Supreme Court of Canada’s leading decision, Canada Trust Mortgage Co. v Canada.

Rejecting the Tax Court’s position that subsection 227.1 is “silent as to when the liability arises”, the Federal Court of Appeal held that the language “at the time” is clear and it can be used to determine which directors are liable and the point in time which a directors’ liability arises, that being the time when a corporation was required to “deduct, withhold, remit or pay” certain amounts but “failed to do so”.

The Federal Court of Appeal pointed to the Tax Court’s failure to draw equal consideration to the French version of section 227.1 in the Income Tax Act and explained that the extent of any ambiguity between the two versions could be eliminated by considering the context and purpose of the provision.

The Federal Court of Appeal also explained that subsection 227.1(2) includes the effect of the “avoidance of double taxation”. In this context, the Minister is prohibited from recovering amounts from directors that have already been paid by the corporation and from collecting amounts in excess of the corporation’s debt once “liquidation, dissolution or bankruptcy proceedings have been commenced”.

The Federal Court of Appeal referenced its previous decision in Smith v Canada which held that subsection 227.1(1) was enacted to empower and strengthen the Crown’s ability to enforce statutory obligations and that such provision is grounded on the presumption that corporate directors can be rendered liable for their corporation’s default on remitting source deductions.

Rejecting the Tax Court of Canada’s purposive analysis of subsection 227.1(1), the Federal Court of Appeal explained that Parliament could not have intended for directors’ liability under subsection 227.1 to be avoided, as it was in the present case. The Federal Court of Appeal explained that explanatory and technical notes (relied on by the Tax Court) “are permissible, extrinsic interpretive aids” nevertheless they are not binding on the court and cannot replace the required “textual, contextual and purposive analysis” of the provisions, as per Canada Trustco Mortgage Co. v. Canada.

Federal Court of Appeal Judgment

The Federal Court of Appeal set aside the Tax Court of Canada’s decision and allowed the Minister’s appeal with costs. The Federal Court of Appeal held that Mr. Colitto’s director liability with respect to Precision’s debt arose “in or in respect of the 2008 taxation year.” The Federal Court of Appeal also dismissed Ms. Colitto’s appeal with respect to the assessment issued to her by the Minister on January 13, 2016 pursuant to section 160 of the Income Tax Act.

Implications of the Federal Court of Appeal’s Decision

The Queen v Colitto made a “first impression” on the Federal Court of Appeal. It is a significant case for corporate directors and for non-arm’s length parties accepting property transfers from these directors. Not only does this case illustrate that the timing associated with a corporation’s failure to meet its tax obligation is crucial to determining when a director’s liability arises, it also reveals how that timing can create a tax liability within the meaning of section 160 of Canada’s tax act.

The Queen v Colitto sheds light on the tax collection provisions in Canada’s income tax act and the CRA’s collection powers and limitations under these provisions. The case speaks to the complexities associated with the interpretation of subsections 160(1) and 227.1(1) of the Income Tax Act and how they interact with one another. Under certain circumstances, as illustrated in this case, the CRA has the power to collect the tax debt of one taxpayer from another person. In all circumstances, these provisions prevent double taxation and protect the collection of taxes.

The Queen v Colitto makes it clear to corporate directors that they must exercise due diligence to prevent a corporation’s failure to remit the required source deduction. This case also cautions corporate directors that failure to exercise due diligence may result in them (the directors) being liable, with the corporation, for its tax debt.  Obviously, as with Ms. Colitto, spouses may also do well to take note.

Tax Tips – Non-Arm’s Length Transfers and/or Director’s Liability

Understanding the collection provisions under the Income Tax Act and the CRA’s collection procedures, powers and limitations is crucial for taxpayers to meet their tax obligations proactively. If you have questions regarding the transfer of property to non-arm’s length or for inquiries regarding director’s liability, please contact our office to speak with one of our experienced Canadian tax lawyers.

Disclaimer:

"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."

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