Taxpayers must pay interest on non-existent tax debts


In The Bank of Nova Scotia v The Queen, the Tax Court of Canada (TCC) discussed how to calculate default interest on an audit adjustment that is offset by a loss carryback. The Court endorsed the Canada Revenue Agency (CRA) charge default interest on the adjustment up to the year of the Audit, not the year of loss. The CRA’s approach may result in substantial amounts of interest, which may exceed the amount (if any) of the actual additional tax owed. Audited taxpayers who have losses available for carry-back should carefully consider their potential arrears interest debt and take steps to minimize it.


Following a transfer pricing audit, the Bank of Nova Scotia (BNS) entered into a settlement with the CRA on March 13, 2015, whereby certain amounts would be included in its income for the 2006 to 2014 tax years. Along with the settlement, BNS requested that the balance of its available non-capital losses from its 2008 tax year be carried over to 2006 to offset the increase in income resulting from the settlement. The CRA agreed but charged BNS interest on the full notional tax payable for 2006 on the date of the carryback request (March 12, 2015) rather than the filing date for the 2008 tax year (April 28, 2009). The SNB was thus charged “default interest” on a notional tax debt for almost six years during which the debt was extinguished.

The relevant provision on the payment of interest on the Income Tax Act (ITA) is paragraph 161 (7) (b), which provides that interest accrues on a tax debt that is offset by a carry-back up to 30 days after the last of the four dates. One of these dates, set out in subparagraph 161 (7) (b) (iv), applies when a reassessment is issued following a written request for carryback, in which case interest accrues. until the date of the request.

The CRA argued that subparagraph 161 (7) (b) (iv) applies in situations like BNS, that is, when the CRA makes audit adjustments during a given tax year that the taxpayer requests to offset through loss carrybacks. Even though no additional tax can be due, the CRA charges interest on the notional amount of tax until the date the “claim” is made – which logically can only happen towards the end of the tax period. verification when adjustments are known. In support of this position, the CRA relied primarily on the case of Connaught Laboratories against Canada (94 DTC 6697 (FCTD)) in support of the proposition that interest can be charged on tax debts that have been extinguished by loss carryforwards.

BNS argued that when enacting subparagraph 161 (7) (b) (iv), Parliament did not intend to charge interest between the date a tax return is filed for a deficit year and the date the result of a subsequent audit is known. This approach is also consistent with the approach taken with respect to other discretionary deductions made available under the Tax Act. In support of its position, BNS referred to the French version of subparagraph 161 (7) (b) (iv) ITA, as well as to a judgment of the Alberta courts relating to the analogous provision of the Alberta Corporations Tax Act (the Queen’s Court of Alberta Bench in Methanex Corp. v Alberta (provincial treasurer), asserted by the Alberta Court of Appeal).


In its reasons, the ICC essentially adopted the reasoning of the ARC, considering that the BNS case was “closer to that of Connaught than Methanex” and that “Methanex is either poorly decided or its reasoning cannot be applied to an appeal under federal law Income Tax Act. The TCC concluded that the wording of paragraph 161 (7) (b) is unambiguous and that, based on the from the Ministry of Finance Technical Notes issued in 1985 when subparagraph 161 (7) (b) (iv) was first adopted, Parliament intended to function in accordance with the ARC position.

Our comment

In our respectful view, a careful examination of the text, context and purpose of subparagraph 161 (7) (b) (iv) strongly supports a different result than that reached by the TCC:

  • Subparagraph 161 (7) (b) (iv) only applies “where, following a written request”, the CRA reassesses the taxpayer to account for a carryback losses. In cases like the BNS, the ARC does not reassess following such a request, but rather to implement the findings of an audit regarding other matters. The application of additional loss carrybacks in such a situation is incidental to the audit adjustments and therefore falls outside the clear wording of subparagraph 161 (7) (b) (iv).
  • The underlying purpose of paragraph 161 (7) (b) – as the CRA itself explains – “is to cover situations where a taxpayer willfully ignores the payment of taxes, anticipating the application of tax. subsequent losses to erase the liabilities ”. In light of this underlying objective, the CRA did not apply subparagraph 161 (7) (b) (iv) in situations where tax obligations were found to be higher than expected as a result of an audit. (see CRA documents 2009-0313781I7 and 2011-0420701I7). It is not known why he chose to abandon this eminently reasonable approach.
  • Prior to the enactment of subparagraph 161 (7) (b) (iv), when a taxpayer carried back losses to offset tax payable in a prior year, interest accrued from the tax year until the year of the loss. In 1985, Parliament amended paragraph 161 (7) (b) to add, among others, paragraph (iv). Officials of the The Finance Department explained to Parliament that these changes were “not of a controversial nature”, but rather “aimed at resolving technical problems which had arisen in the administration and enforcement of the Income Tax Act”. Therefore, Parliament enacted subparagraph 161 (7) (b) (iv) with the understanding that it did not depart significantly from prior law. It follows that subparagraph 161 (7) (b) (iv) must be interpreted restrictively.
  • Connaught related to taxation years prior to the enactment of subparagraph 161 (7) (b) (iv). The case simply ignores the thesis that default interest can accrue on a tax debt during the period in which the debt is extinguished.
  • By definition, interest is intended to compensate for the use of money, and it is unreasonable to charge interest on extinguished debts. At a minimum, if Parliament really intended to achieve such a result, parliamentary proceedings would surely show a clearer record of that intention.

For all these reasons, we hope that the Federal Court of Appeal (FCA) will set the record straight, as it did earlier this year in Canada versus Villa Ste-Rose Inc., which also involved a situation in which the tax authorities had adopted the questionable policy of charging interest (and penalties) on non-existent tax liabilities, in this case related to the GST.

Implications for taxpayers

Until and unless the FCA weighs, taxpayers looking to offset audit adjustments with loss carryforwards should take steps to calculate the expected interest liability (which can extend well beyond the loss year) and take action to minimize it, for example through the interest set-off provisions of the ITA, the use of other discretionary deductions or the request for discretionary interest relief. Ideally, these steps should be taken before any reassessment is issued.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

Sir Michel LubetskiDavies Ward Phillips & Vineberg
155 Wellington Street
M5V 3J7
Phone. : 4168630900
Fax: 4168630871
Email: [email protected]

© Mondaq Ltée, 2021 – Tel. +44 (0) 20 8544 8300 –, The source Company briefing

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