Federal Court of Appeal Rules that Arrears Interest Exceed Tax Payable Following Audit and Loss Carryback Request
In Bank of Nova Scotia v His Majesty the King,[1] the Federal Court of Appeal (“FCA”) upheld the Tax Court’s decision that arrears interest can accrue to the date of a long-delayed reassessment, even though the increased tax liability was almost entirely offset with a loss carryback.
The decision turned on the interpretation of subparagraph 161(7)(b)(iv),[2] under which the Minister had assessed interest on the taxpayer’s gross tax payable in respect of the reassessed taxation year rather than on the net amount after applying a loss carryback. The interest imposed ($7,931,087.49) far exceeded the taxpayer’s tax owing after the loss carryback (about $1 million).
Background
As a result of a transfer pricing audit, the Minister reassessed the Bank of Nova Scotia (the “Bank”) for its 2006 to 2014 taxation years to include additional amounts in its income. The Minister and the Bank reached a settlement agreement on March 13, 2015, which resulted in a Part I income increase of $54,916,616 for the 2006 taxation year (the “Transfer Pricing Adjustment”).[3] One day prior to entering the settlement agreement, the Bank requested the carryback of a $54,000,000 non-capital loss that arose in its 2008 taxation year (the “Loss Carryback”) to offset the additional taxable income resulting from the Transfer Pricing Adjustment for 2006.[4]
The Minister issued a notice of reassessment on March 20, 2015 reflecting both the Transfer Pricing Adjustment and the Loss Carryback. However, the Minister assessed interest in the amount of $7,931,087.49 accruing from the Bank’s balance-due day for 2006 until March 12, 2015, being the date on which the Bank requested the Loss Carryback.[5]
The Bank appealed from the reassessment, arguing that the Loss Carryback should have been applied to stop the “interest clock” (a term used throughout the decision) in respect of the Transfer Pricing Adjustment on the date that the Bank filed its tax return for its 2008 taxation year. The Bank lost at the Tax Court and appealed to the FCA.
Subsection 161(7)
Taxpayers owe arrears interest on unpaid balances. Pursuant to subsection 161(1), the interest generally starts accruing on the “balance-due day”,[6] which for a public corporation is generally two months after the end of the relevant taxation year. Interest will stop accruing on the date that the balance owing is paid.
However, if a taxpayer reduces its tax payable for the relevant taxation year via a deduction from taxable income (such as a loss carryback), interest may stop accruing on a different date, such as the date that the taxpayer requested the deduction. Paragraph 161(7)(b) modifies the general rule if certain deductions apply, allowing a taxpayer to stop the interest clock for outstanding tax arrears on the latest of the four dates listed in subparagraphs (i) to (iv).[7] In the Decision, the two relevant dates are provided in subparagraphs (ii) and (iv), which state:
(ii) the day on which the taxpayer’s or the taxpayer’s return of income for that subsequent taxation year was filed; […] and (iv)where, as a consequence of a request in writing, the Minister reassessed the taxpayer’s tax for the year to take into account the deduction or exclusion, the day on which the request was made. | (ii) le jour où la déclaration de revenu du contribuable ou de son représentant légal pour cette année d’imposition ultérieure a été produite, […] et (iv) le jour de la demande écrite à la suite de laquelle le ministre établit une nouvelle cotisation concernant l’impôt du contribuable pour l’année et qui tient compte de la déduction ou de l’exclusion, dans le cas où il y a une telle nouvelle cotisation. |
The FCA Decision
The issue was whether the interest clock stopped when the return for the Loss Carryback was filed (under subparagraph 161(7)(b)(ii)) or when the taxpayer requested the Loss Carryback (under subparagraph 161(7)(b)(iv), which would result in a large arrears interest balance).
The parties disagreed as to whether the language of subparagraph 161(7)(b)(iv) encompasses a circumstance where the reassessment was not made as a consequence of the carryback request but to process an audit adjustment. The FCA held that subparagraph 161(7)(b)(iv) applied even though the reassessment in issue was the result of an audit adjustment.[8]
More specifically:
- The text of subparagraph 161(7)(b)(iv) was ambiguous as to whether reassessments caused by audit adjustments (that incorporate a loss carryback requested by the taxpayer) are different than other requests for loss carrybacks.[9]
- Parliament intended to stop the clock at the later time even if a loss carryback was requested as a result of an audit adjustment. Parliament seeks certainty, predictability, and fairness when drafting tax legislation and so, according to the FCA, Parliament would have used explicit language if it had intended the clock to stop at an earlier time.[10]
- Parliament did not establish a harmonious scheme for the calculation of interest. There is an inconsistent income tax treatment of loss carrybacks versus loss carryforwards. When a loss carryforward is applied, no interest is imposed, regardless of when the loss carryforward is requested.[11] Given this lack of a harmonious scheme for the calculation of interest, the FCA refused to treat the loss carrybacks in a similar manner to discretionary deductions available in the reassessed taxation year.[12]
- Stopping the clock when the return was filed would be anomalous. The Court agreed with the Crown that the Bank’s interpretation of subparagraph (b)(iv) would lead to anomalous results, potentially starting the interest clock in a different year when the audit adjustment and loss carryback were imposed by two separate reassessments as opposed to a single reassessment.[13]
- Notably, Parliament was likely aware that subparagraph (b)(iv) could produce punitive results. The FCA concluded that it is “likely that Parliament knew that subparagraph (b)(iv) could function in a manner similar to a penalty”[14] and the FCA held that a taxpayer requesting a carryback in response to an audit was not an “obscure” scenario. The FCA relied on the text of the provision in holding that the Act “would have spoken more clearly” if Parliament wished to avoid the outcome of an interest provision functioning as a penalty to the taxpayer.[15]
Takeaways
Most practically for taxpayers, the FCA provides important guidance on when the interest clock stops if loss carrybacks are applied. Taxpayers now know that interest will continue to accrue, even interest arising from an audit adjustment, until the taxpayer requests the loss carryback. The Court’s conclusion is particularly relevant in situations where there is an extended or unlimited reassessment period, as the passage of time can lead to substantial interest accruals. Accordingly, taxpayers may consider requesting the waiver or cancellation of interest under subsection 220(3.1).
Further, many taxpayers find themselves in scenarios where an ambiguous tax provision is applied to circumstances that – while not routine – are not “obscure”. If tax authorities assert that a seemingly inappropriate result should be avoided, taxpayers should be aware that a contextual argument is available to them that Parliament “would have spoken more clearly” if it intended to avoid such a result.
[1] 2024 FCA 192 (the “Decision”).
[2] Unless otherwise indicated, all statutory references are to Income Tax Act, RSC, 1985, c. 1 (5th Supp.) (the “Act”).
[3] The Decision at para 5, agreed statement of facts para 8.
[4] The Decision at para 5, agreed statement of facts para 9.
[5] The Decision at para 5, agreed statement of facts para 10.
[6] As defined in s. 248(1).
[7] In full, paragraph 161(7)(b) provides:
“161 (7) For the purpose of computing interest under subsection 161(1) or 161(2) on tax or a part of an instalment of tax for a taxation year, and for the purpose of section 163.1, (…)
(b) the amount by which the tax payable (…) is reduced as a consequence of the deduction or exclusion of amounts (…) (a) is deemed to have been paid on account of the taxpayer’s tax payable under this Part for the year on the day that is 30 days after the latest of
- the first day immediately following that subsequent taxation year,
- the day on which the taxpayer’s or the taxpayer’s legal representative’s return of income for that subsequent taxation year was filed,
- if an amended return of the taxpayer’s income for the year or a prescribed form amending the taxpayer’s return of income for the year was filed under subsection 49(4) or 152(6) or (6.1) or paragraph 164(6)(e), the day on which the amended return or prescribed form was filed, and
- where, as a consequence of a request in writing, the Minister reassessed the taxpayer’s tax for the year to take into account the deduction or exclusion, the day on which the request was made.”
Parliament added subparagraph 161(7)(b)(iv) in 1985.
[8] Decision at paras 35, 36, and 67.
[9] Decision at para 37.
[10] Decision at para 39. The FCA also found at para 43 that the technical notes showed that the provision should apply where the Minister accedes to the taxpayer’s request for a loss carryback.
[11] Decision at para. 52.
[12] Decision at para. 53.
[13] Decision at para 44.
[14] Decision at para. 50.
[15] Decision at para. 50.