Because its shareholders and directors didn’t understand the rules, he corporate taxpayer stood to lose $1,442,760 of dividend refunds, plus about $600,000 of penalties and interest. It tried to persuade the Court that the refund rule should be interpreted generously to prevent that harsh result.
Here, Justice Bocock gives us a helpful explanation of an important principle of income tax law, “Integration”, and how the refundable dividend and Part IV rules of the ITA helps realize that goal.
“[1] The principle of integration in tax law refers to the desired balance and parity optimally achieved under the Income Tax Act(“Act”) as among or between certain distinct entities: usually individuals and corporations. Entire sections and parts of the Act are dedicated towards achieving this goal. Part IV of the Act seeks to achieve integration as between corporations and individual shareholders on the issue of corporate dividends. Corporations initially pay tax upon declaring dividends, but once individual shareholders include the dividends in income and pay tax on same, the corporation, subject to certain conditions, is entitled to a “dividend refund” as defined in subsection 129(1). The interpretation of one of those conditions is the essence of this appeal.”
The purpose of the Part IV rules is “to place an individual who holds [private corporation] shares through a private holding company in the same position as one who holds such shares directly. It prevents individuals from holding dividend-yielding shares in order to defer, perhaps permanently, paying tax on such dividends.” The related refundable dividend tax on hand rule in s. 129 is directed more broadly to include “passive income” from property, such as rent, interest or capital gains.
Without Part IV and the refundable dividend tax rules, the fear is that taxpayers would use corporations to earn investment income, paying only the generally lower corporate income tax rate, allowing them to earn income quicker in a corporation than they could if they held the investments directly (and not through the corporation). So, as Bocock J says, we add on a temporary high rate tax the goal of which is to make the corporation pay the same amount of tax as if the individual earned the money directly and paid tax at the top rate. When the corporation pays out a dividend to a shareholder, it gets back the Part IV tax and higher rate tax on investment income, equal to up to 1/3 the amount of the dividend paid. An individual shareholder who gets the dividend will then pay tax on the dividend. In this way, there is no “deferral” of tax (such as you might get through an RSP, for example).
“[2] Specifically, the dividend refund is due to the corporation provided it has indeed paid the dividend and is a “private corporation”. The dividend refund is paid “by the Minister” to the corporation where the corporation’s income tax return is made within 3 years after the initial dividend is paid to the shareholder.
“[3] In the present appeal, the Minister submits that a failure to file such tax returns within the described 3 year period after the year the dividend has been paid is fatal to an entitlement to receive the dividend refund. …”
“[20] … [The Part IV and refundable dividend tax system] seeks to place an individual who holds such shares through a private holding company in the same position as one who holds such shares directly. It prevents individuals from holding dividend-yielding shares in order to defer, perhaps permanently, paying tax on such dividends.”
Justice Bocock had no trouble concluding that “‘the failure to file the tax return within the three year period referred to subsection 129(1) of the Act, “made the dividend refund provision in subsection 129(1) inoperative … and the refund unobtainable”.'” For this view, he relied on earlier decisions in Tawa Developments Inc v R, 2011 TCC 440 (CanLII), Ottawa Ritz Hotel Co. v Canada, 2012 TCC 166 (CanLII) (para. 4) Ottawa Air Cargo Centre Ltd v R., 2007 TCC 193 (CanLII) at paragraphs 36, 37 and 38 (subsequently affirmed by the Federal Court of Appeal at 2008 FCA 54 (CanLII)).
Justice Bocock didn’t consider the rule to be unfair, though it allows the Government a “windfall” of tax:
“[29] … Again it is difficult to envisage a more fundamental obligation on a taxpayer assigned under the Act than that of filing its returns of income; the timely filing of returns is central “to the object intended to be secured by the Act” …
“[30] This timely and time sensitive requirement to file is embedded throughout the Act. Parliament certainly intended that much. Logically, failing to do so gives rise to various sanctions: penalties, interest, alternative assessments, denial of tax refunds, and in this case, dividend refund forfeitures. It may be unfair, unilateral and even draconian, but its central and overarching context and purpose is the requirement to file the prescribed “income tax return” for a prescribed “tax year” within a “filing deadline” established under the “Income Tax Act”.”