Business structure and corporate tax planning are critical parts of a business venture, regardless of a company’s size. The lack of due diligence can leave a business vulnerable to scrutiny by courts and the Canada Revenue Agency and may result in serious tax and legal consequences.
An example of this is found in the Tax Court of Canada’s appeal decisions in the parallel cases of Lauria v. The Queen and Freedman v. The Queen. The cases, which were decided together, involved the sale of business shares to family trusts only months before a business went public and the reassessment by Canada Revenue Agency triggered by the sale.
Business partners transferred shares to family trust prior to IPO
The two individual appellants, Lauria and Freedman, held senior positions and were shareholders of a business that provided wealth management services. The business, Gluskin Sheff + Associates Inc. (GS+A), was independently owned by the appellants and others. At the time the appellant purchased their shares, the shares were issued as Common Shares.
In February 2006, the appellants were told that the founders had decided to take the company public and pursue an initial public offering of shares (IPO). They were advised to work with a financial planner to transfer a portion of their shares into a family trust. Freedman transferred 3,000 Common Shares, valued at $77,340, while Lauria transferred 1,000 Common Shares at a price of $25,780. They each filed a T1 General Tax Return reporting these sales.
Share value increased exponentially upon IPO sales
GS+A created three share classes before the Initial Public Offering. The Common Shares held by the appellants were converted into Subordinate Voting Shares. Freedman’s 3,000 Common Shares became 86,400 Subordinate Voting Shares, while Lauria’s 1,000 Common Shares became 28,800 Subordinate Voting Shares.
Further to the terms of the IPO, the trusts, as shareholders, were obligated to sell these Subordinate Voting Shares. The sale took place on May 26, 2006. Freedman’s trust brought in $1,598,000 from the sale, while Lauria’s trust sold its shares for $495,418.
The appellants’ tax returns were not reassessed until 2017, more than 10 years after they were filed. The Canada Revenue Agency (CRA) determined the shares had been undervalued when sold to the family trusts and that they should have been sold closer to what they were valued at only a short time later (after the IPO). As the CRA labelled this issue a misrepresentation, it was able to conduct a reassessment past its normal 10-year limitation. The appellant partners, Lauria and Freedman, denied that there had been a misrepresentation and appealed the reassessment.
Misrepresentation allows CRA to extend reassessment limitation period, regardless of intent
The Tax Court of Canada first considered whether the Canada Revenue Agency was able to issue a reassessment past the usual 10-year window.
The court held that even if the appellants did not intentionally mislead the CRA in their tax returns, that intent is not required. Simply failing to take reasonable steps to ensure tax compliance is enough to cross the threshold needed to allow the CRA to reassess their taxes after the limitation period has expired.
The second issue considered by the Tax Court was whether the shares had been sold to the family trusts for fair market value.
The appellants argued that when they sold the shares, the IPO had not yet occurred. As a result, the prices paid represented the fair market value at the time. The Canada Revenue Agency asserted that while the IPO may not yet have occurred, the appellants knew it was coming and understood that the shares would increase in value once the company had been taken public.
The Tax Court agreed with the CRA’s argument. It found that while the appellants were not majority shareholders or founders of the company, they should have known that a windfall was imminent, particularly as the IPO occurred just six weeks after the sale to the family trusts.
Misrepresentation “negligent and careless” in light of appellants’ status as financial professionals
After establishing that the appellants’ had committed a misrepresentation in their tax returns, the Tax Court turned to the question of whether it was attributable to neglect, carelessness, or wilful default.
The court agreed with the Canada Revenue Agency’s assertion that the appellants’ misrepresentation was “negligent and careless”. Both appellants were financial professionals who were aware of the effect of an IPO on a company’s stock values. The court also noted that the estate planning undertaken by the appellants would likely have been done with the knowledge that their stock values would rise following the IPO.
Additionally, the court found that the appellants were negligent in failing to engage independent legal counsel to confirm the value of their shares or the extent of their expected price increase at the time of the IPO. The court held that a wise and prudent person would have sought counsel on such a large decision.
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