Tax battle between the CRA and Canada's big banks shows no signs of abating.

MAJOR TAX BATTLE BETWEEN THE CRA AND BIG BANKS SHOWS NO SIGNS OF ABATING

Amajor tax battle between the Canada Revenue Agency and the country's six biggest banks has more than doubled in size over the past few years, with the lenders saying they are being reassessed for in excess of $6 billion due to a disagreement over dividends.

Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada and Toronto-Dominion Bank all say they believe their tax filings are sound. However, the banks have acknowledged in corporate filings that the CRA and provincial tax agencies continue to reassess them for a growing mountain of money.

The Big Six reported in their most recent quarterly filings that, as of the end of October, tax authorities were seeking or proposing to seek approximately $6.3 billion in additional tax and interest from them combined over dividend-related matters. When the Post last wrote about the tax dispute, in June of 2018, the potential bill that had been disclosed at that point had reached around $2.8 billion.

The deepening dispute comes as the coronavirus pandemic has stretched the federal government's finances in ways not seen since the Second World War, and as the CRA has been funded and tasked to try to root out tax avoidance.

All of the banks declined to comment further on the matter to the Post. For its part, the agency says the confidentiality provisions of the Income Tax Act prevent it from discussing specific cases.

“As well,” a spokesperson added in an email, “the CRA does not disclose specific techniques or approaches to detecting and combating tax evasion and aggressive tax avoidance as it could provide a roadmap for other non-compliance.”

What is known about the dispute from quarterly shareholder reports, government documents and court filings is that it revolves around the tax deductibility of dividends received by the banks. Companies are generally allowed to deduct from their income the amount of a dividend they've received from holding shares of a fellow Canadian corporation, as those dividends are paid out of after-tax earnings that the government wants to avoid double-taxing. There are, however, some exceptions.

One such exception is when there is a structure in place that chiefly aims to get a taxpayer a deductible dividend while the risk of loss or opportunity to profit off the share rests with someone else. And it is these rules around what are known as “dividend rental arrangements” that some banks say have triggered reassessments.

Rental arrangements have been on the government's radar for years, but the banks did not start reporting that the CRA was reassessing them for dividend-related issues until their 2016 fiscal years.

Those disclosures followed a legislative tweak announced in the 2015 federal budget that was aimed at extending the dividend rental arrangement exception to “synthetic equity arrangements,” which the document said were being entered into by certain taxpayers, “typically financial institutions.”

Those arrangements entail using an equity derivative — the value of which can be tied to the market movement of stocks — that see the taxpayer maintain legal ownership, but the risk of owning a share transferred to another party. Generally, the government said, a taxpayer will make “dividend-equivalent payments” to the other party that get deducted as well, which, when the other party is exempt from paying taxes, can chip away at the government's tax revenue.

The federal government said in the 2015 budget that synthetic equity arrangements could be challenged based on existing rules, and depending on the facts of the case. The amendment, the budget suggested, would avoid “time-consuming and costly” legal fights.

However, a source close to the dispute told the Post in 2018 that the CRA was going around challenging transactions that had been left alone for more than 20 years. The government's interest also appears to have coincided with a demand for synthetic equity among clients of the banks.

Former Healthcare of Ontario Pension Plan CEO Jim Keohane wrote a letter to the finance minister in 2015 saying that synthetic equity was a “critically important risk

management tool” for his fund. He recommended that Ottawa not proceed with the changes (which wound up coming into full effect for dividends paid or payable after April 2017, rather than the initially proposed October 2015), and suspected they would have negative effects for other market participants.

“The use of synthetic equity exposure in the HOOPP portfolio structure frees up the cash that would otherwise be invested in physical equities which is then redeployed in other investments, more specifically government bonds,” Keohane wrote.

Some lenders have mentioned alleged dividend rental arrangements in their filings, while others say it is merely a dividend-related issue.

The tax years being disputed thus far range from as recent as 2015 to as far back as 2009. BMO's corporate filings say it has been reassessed for approximately $941 million in additional tax and interest, CIBC approximately $1.115 billion, National Bank approximately $610 million, Scotiabank approximately $1.025 billion, RBC approximately $1.527 billion and TD approximately $1.091 billion.

RBC, the country's largest bank, noted the legislative changes in its 2020 annual report, saying the moves introduced in the 2015 federal budget “resulted in disallowed deduction of dividends from transactions with Taxable Canadian Corporations including those hedged with Tax Indifferent Investors, namely pension funds and non-resident entities with prospective application effective May 1, 2017.”

The bank also added that the dividends in question include both those “in transactions similar to those which are the target of the 2015 legislative amendments and dividends which are unrelated to the legislative amendments.”

CIBC filed a notice of appeal to the Tax Court in 2018 that said it received dividends from shares it was holding to hedge its market exposure from swap contracts entered into with Canadian pension funds. As a result, the bank said it had deducted almost $420 million from its income for 2011.

The CRA, though, alleged the lender had really entered into a dividend rental arrangement and denied the deduction. It also invoked the general anti-avoidance rule of the Income Tax Act, which tries to prevent transactions geared solely towards getting tax benefits.

CIBC objected to both claims. The appeal was withdrawn near the end of 2020 after CIBC's 2011 tax year was hit by another reassessment, to which CIBC also objected, according to Tax Court documents.

TD has reported that it is dealing with provincial tax authorities, in addition to the CRA. According to the bank's 2020 annual report, Revenu Québec and the Alberta Tax and Revenue Administration have denied certain dividend deductions the bank claimed. And like other lenders, additional reassessments are a possibility.

“The Bank expects the CRA, RQA, and ATRA to reassess open years on the same basis,” TD said. “The Bank is of the view that its tax filing positions were appropriate and intends to challenge all reassessments.”

Yet challenging a reassessment and winning that challenge are two different things.

It can take “easily 10 years” between objecting to a CRA reassessment and a potentially precedent-setting ruling from the Supreme Court of Canada, according to Jonathan Farrar, an accounting professor at Wilfrid Laurier University.

“And that's one of the reasons why the CRA is very reluctant to want to challenge taxpayers unless they really think that they can win, because the process is enormously time consuming and obviously very expensive,” Farrar said. “But if they think they have a greater than 50 per cent chance of winning, then they're going to pursue it.”

The banks' filings show that the CRA has yet to drop the matter, and recent developments that have seen the government project a historic budget shortfall while also touting its efforts to combat tax avoidance may be an indication that it is unlikely to do so any time soon.

The fall economic update tabled at the end of November by the Trudeau government projected a $381.6-billion deficit for the current 2020-21 fiscal year. It also said that the government was planning on consulting in the coming months on a “modernization” of anti-tax-avoidance rules.

“For too long,” the document said, “certain individuals and businesses have been able to create increasingly complex structures in order to artificially lower their tax obligations in a manner that does not serve an economic purpose, including by shifting profits offshore and creating artificial tax deductions.”

The moves come on top of funding the government has earmarked in recent years for the CRA to tackle tax avoidance and evasion, as well as an additional $606 million over five years that November's fall economic statement pledged for similar pursuits. It also follows further dividend-related tax changes announced in the 2018 budget.

Combine the CRA's resources with a few legislative tweaks and you have a federal tax agency that appears set on scrapping with the country's six biggest banks, which paid $12.7 billion in taxes to all levels of government in 2019, according to the Canadian Bankers Association.

The purpose of an October 2019 presentation provided to a corporate committee of the CRA was to show how the agency's compliance programs “are becoming more strategic about high impact audits, namely dividend rental arrangements,” according to documents obtained by the Post.

Expected outcomes were said to be discussion about the current approach, as well as “new opportunities” that could emerge in the future.

“Certain taxpayers continue to engage in abusive arrangements intended to circumvent the dividend rental arrangement rules,” the presentation said. “The compliance programs in the CRA are working on a strategic approach to target these taxpayers.”

THE CRA IS VERY RELUCTANT TO CHALLENGE TAXPAYERS UNLESS THEY THINK THEY CAN WIN.

CHRIS ROUSSAKIS / QMI AGENCY `Dividend rental arrangements' have been on the government's radar for years, but the banks did not start reporting that the CRA was reassessing them for dividend-related issues until their 2016 fiscal years.