Despite generating more than $3 million for APC between 2007 and 2010, Aitchison took no salary or dividends for most of the years in question while his daughters, who are also lawyers in the same office, took home more than $1 million in salary and dividends.
The CRA delivered a notice of assessment to the firm for $2.1 million in 2012, invoking s. 160 (1) of the Income Tax Act, which comes into play when taxpayers transfer property to spouses, minors or other people dealt with at non-arm’s length, claiming Aitchison had transferred to APC his “right to invoice for legal services.”
But Graham ruled the CRA’s claim must fail because the right to invoice falls outside the definition of “property” under s. 160.
“The Respondent is trying to take something that is clearly the provision of a service and make it a transfer of property,” Graham wrote in his July 6 judgment, characterizing Aitchison as a volunteer or employee of APC.
“If an employee negotiates a poor contract, the potential salary that he or she leaves on the table is not ‘property’ that he or she has transferred to his or her employer. It is simply a lost opportunity,” the judge added.
Describing the outcome as “distasteful,” the judge nevertheless warned the federal government not to overreact legislatively.
“It was clear to me that, starting in 2003, James had one overriding goal: defeating the CRA by diverting all of what would otherwise have been his income to his daughters,” Graham wrote.
“This case demonstrates that there is clearly a gap in section 160. It cries out for that gap to be fixed. However, I would caution Parliament against inadvertently extending the reach of section 160 too broadly. Simply amending section 160 to cause it to cover the non-arm’s length provision of services may have undesired consequences,” he added.
Adrienne Woodyard, a partner in the tax law group at DLA Piper Canada LLP, acted for APC. Had the court accepted the CRA’s arguments, she said in a statement to Law Times, it would have turned “upside down the manner in which legal professional corporations and their owners file for tax purposes.”
“It would follow from that theory that a lawyer practising through a professional corporation must recognize the disposition of property — i.e., his or her ‘right to invoice’ to the corporation — every time the corporation issues an invoice for the lawyer’s services,” Woodyard said, noting that the case was unlike many others involving s. 160, which typically see an otherwise non-taxable gift made to a family member.
“In this case, tax was paid both by the corporation and Mr. Aitchison’s daughters on the profits derived from the legal services that Mr. Aitchison performed,” Woodyard continued.
Dean Blachford, a tax litigator with Hazlow Law in Ottawa, who was not involved with the case, says the CRA was always fighting an uphill battle. Still, he understands why it took the case to trial.
“They were on tenuous ground, but there was a bit of a grey area in terms of what’s considered property,” he says.
Blachford frequently represents family members and business partners who benefited from transfers targeted by the CRA under s. 160, and he says the clause is already a formidable weapon for tax collectors without further additions.
“A lot of people call it the teeth of the Income Tax Act because it’s such a broad and aggressive provision and there are all sorts of ways it can be punitive. I see a lot of innocent people pulled in,” he says.
David Rotfleisch, founder of tax law firm Rotfleisch & Samulovitch PC, says the case is just the latest in a line of inappropriate enforcement actions by the CRA.
“I am delighted by this result because it was a gross overreach by the CRA to have attempted to apply s. 160 in these circumstances,” he says. “From the point of view of taxpayers, we don’t like it that someone has avoided paying millions, but the law is the law and s. 160 only applies in certain limited circumstances.”
The fact situation that led to the assessment is so rare that he questions whether any amendment to the ITA is called for.
“It’s arguably applicable to other professions, but they’d need to be all working in the same profession to recreate this very specific set of circumstances,” Rotfleisch says.
“Any attempt to legislate is likely to backfire and create a whole lot of new problems for ordinary people.”
But William Innes, a tax litigator with Rueters LLP in Toronto, says the case is ripe for appeal, calling Graham’s decision a “narrow interpretation” of s. 160 (1).
“I don’t think an amendment is necessary,” he says. “I’d be very surprised if there is no appeal, because it’s not a result that will sit well with the general public reading the decision.”
A Department of Justice official declined to comment, noting that the Crown still has until October to launch an appeal.