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Federal Tax - Interest. Bank of Nova Scotia v. Canada
In Bank of Nova Scotia v. Canada (Fed CA, 2024) the Federal Court of Appeal dismissed a tax appeal, here from "a decision of the Tax Court of Canada which confirmed a reassessment imposing interest for late payment of tax":[1] The Bank of Nova Scotia appeals to this Court from a decision of the Tax Court of Canada which confirmed a reassessment imposing interest for late payment of tax (the Decision, per Justice Wong, cited as 2021 TCC 70). The Bank’s appeal concerns the calculation of interest in circumstances where a reassessment has taken into account an audit adjustment and an offsetting loss carryback.
[2] In 2015, the Bank received a notice of reassessment for its 2006 taxation year, resulting in a small increase in tax. In making the reassessment, the Minister of National Revenue (the Minister) implemented an approximately $55 million audit adjustment, raising the Bank’s 2006 income, and also took into account a loss carryback of $54 million, reflecting a 2008 non-capital loss. As a result, the reassessment increased the Bank’s taxable income by about $1 million, and increased tax accordingly.
[3] Strikingly, the Minister also imposed interest resulting from the reassessment in the amount of $7,931,087.49. While interest on late payment of tax is generally calculated on the amount of tax owing (i.e., tax on $1 million in this case), a special provision applies if a loss carryback or other specified deduction has been taken: Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (ITA), s. 161(7). This provision requires that, for a specified period of time, interest is calculated by ignoring the loss carryback or other specified deduction. In this case, that means rather than calculating interest on tax imposed on $1 million as assessed, interest for a period of time is calculated on a notional amount of tax that would be payable if the loss carryback were ignored and the Bank’s taxable income were $55 million instead.
[4] While the parties agree that subsection 161(7) of the ITA must be applied in this case, they disagree as to the period to which it applies. The Tax Court concluded that the loss carryback should be ignored for approximately eight years. The Bank appeals this decision, arguing that the carryback should be ignored for only two years. As I will explain, I would dismiss the appeal.
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[10] The rate of interest, set by regulation, is generally the Government of Canada three month Treasury Bill rate plus four percent. The rate is determined quarterly, and compounded daily. (See Income Tax Regulations, C.R.C., c. 945, ss. 4300-4301; ITA, s. 248(11).)
[11] The general rule is modified by subsection 161(7) of the ITA, which applies if specified deductions or exclusions have been carried back to the relevant taxation year. One such deduction is a loss carryback that has been deducted pursuant to section 111 of the ITA (s. 161(7)(a)(iv)).
[12] If the modified rule in subsection 161(7) applies, interest is computed until a specified date as if the deduction or exclusion was not applied (s. 161(7)(a)). Effectively, the deduction or exclusion is ignored for this period of time. When the period of time ends, interest is calculated thereafter under the general rule, which takes the deduction or exclusion into account.
[13] The modified rule ceases to apply 30 days after the latest of four end dates listed in subparagraphs 161(7)(b)(i)-(iv). Where the relevant deduction is a loss carryback, the first two end dates, listed in subparagraphs (i) and (ii), are days that are shortly after the end of the loss year. The remaining two end dates, listed in subparagraphs (iii) and (iv), are days on which the loss carryback is requested.
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[15] A loss carryback rule similar to subsection 161(7) was first enacted approximately 70 years ago (Income Tax Act, R.S.C. 1952, c. 148, s. 54(8)). According to the Senate debates from that time, the objective of this legislation was to discourage taxpayers from deciding not to pay tax that was reported because they anticipated having a subsequent loss that could be carried back to offset the income (Debates of the Senate, 22nd Parl., 1st Sess., vol. 1 (10 June 1954) at 594 (Hon. Salter Hayden)). Under the original provision, the interest calculation ignored a loss carryback until the end of the loss year. This is similar to subparagraph 161(7)(b)(i) in the current legislation.
[16] This appeal concerns a significant change made to subsection 161(7) in 1985. Notably, Parliament added the provision that is at issue in this appeal, subparagraph 161(7)(b)(iv). At paras 22-67 the court analyses the case, which is largely a matter of statutory interpretation, and concludes in the Crown's favour.
Subsequently, the court considers the argument that this interpretation of interest is inconsistent with conventional usage of the concept:(d) Punitive aspect
[48] The Bank submits that the Crown’s position does not reflect Parliament’s intent because it flies in the face of the general theory of interest, which is to compensate for the use of funds. The result is harsh, the Bank suggests, because it did not have use of the funds once the loss was incurred. Put another way, the Bank suggests that the Crown’s position results in a penalty being imposed, which is not the purpose of the interest provisions. The Bank also suggests that Parliament recognizes that the ITA is complex, and there can be differences of opinion that reflect honestly held views.
[49] The Bank’s argument that the Crown’s position ascribes a punitive aspect to subparagraph (b)(iv) appears to be reinforced by the Crown’s written submissions in this appeal which underscore the tax avoidance element of the provision: "“The Minister’s audit power is an essential tool that works in addition to self-reporting, to prevent taxpayers from avoiding their full share of taxes. … The fact that [the Bank’s] income was detected through an audit instead of having been reported is no reason to relieve [it] from the effect of subparagraph 161(7)(b)(iv).”"
[50] However, contrary to the Bank’s argument, Parliament must have been aware that a loss carryback might well be requested as a result of an audit adjustment. I agree with the Crown that this scenario is not obscure. It is, therefore, likely that Parliament knew that subparagraph (b)(iv) could function in a manner similar to a penalty. It is also likely that Parliament knew that substantial interest could accrue under subparagraph (b)(iv) if the carryback request resulted from an audit. Despite the Bank’s forceful arguments, I conclude there is no reason to think that Parliament did not intend this result. Had Parliament wished to avoid this outcome, it would have spoken more clearly.
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