Flawed Canadian Tax Shelter Penalties Hit Tax Executives and Other Employees.

TEI recently commented on proposed draft legislation that would impose personal liability for penalties on company employees for making "false statements" or omissions that lead to a reduction in the company's income or excise taxes. The comments, which took the form of a letter dated January 14, 2000, from TEI President, Charles W. Shewbridge, III to the Paul Martin, the Canadian Minister of Finance, objected to the breadth of the provisions and the odious excessive penalty regime. Calling the provisions "misguided" and seriously "flawed," TEI urged the Minister to withdraw the legislation or substantially revise it.

The draft legislation, which is captioned "Misrepresentation of a Tax Matter by a Third Party," was released by the Minister on September 10, 1999, and included in a Notice of Ways and Means Motion introduced in the House of Commons on December 7. The provisions, which respond to the call of the Canadian Auditor General for penalties against promoters of abusive tax shelters, reach far beyond that purpose, TEI said. Hence, the proposed standard for culpable conduct could lead to the assertion of penalties against company employees for acts or omissions tantamount to mere negligence.

TEI also noted that government representatives have averred, and the Revised Explanatory Notes to the draft legislation explain, that the penalty provisions are not intended to apply to an honest error of judgment or a good faith difference of opinion about the interpretation of the Acts. "Nevertheless," TEI said, "the legal threshold for invoking the penalty -- 'indifference as to whether [the] Act is complied with' -- is potentially so low and its interpretation and application to factual circumstances so highly subjective that the examples [in the Explanatory Notes] raise as many questions as they answer." TEI said the provision will prove both unsound and unworkable. It observed that the mere threat of the assertion of civil penalties against a corporate employee for any reassessment could significantly alter the conduct and tenor of corporate tax audits, exacerbate the scope and degree of tax controversies, and increase taxpayer and government litigation costs. To illustrate the uncertainty surrounding the potential scope and application of the proposed legislation, TEI posed a series of examples and questioned how the government would administer the penalty regime in each case.

TEI said that as important as the lowering of the bar for the imposition of personal liability to a penalty is the sheer magnitude of the proposed penalties. Under the proposal, the penalty is the greater of $1,000 and 50 percent of the tax reduction attributable to a false statement. Given the tremendous complexity of both the tax law, TEI said it was "highly concerned that even the slightest mis-step -- a mere foot fault -- by a corporate employee could lead to Draconian personal penalties.... Consequently, employees involved in the tax planning for, or the mere reporting of, transactions on company tax returns would be exposed to an enormous penalty..., that could easily exceed an employee's lifetime earnings." TEI said the recruiting and retention of qualified company employees would be significantly impaired by the enactment of the provisions. This, in turn, would diminish the accuracy of reported tax liabilities and impair the efficiency of government tax audits.

TEI urged the government to withdraw the draft legislation or substantially revise it to make it inapplicable to corporate employees acting within the scope of their employment at the direction of the employer. At a minimum, the comments said, the "indifference" standard for "culpable conduct" should be eliminated or made inapplicable to corporate employees in respect of their employer's liability. Finally, the comments said, a civil penalty for corporate employees who knowingly make "false statements" that lead to an improper corporate tax reduction should be capped at $1,000 per instance of culpable conduct.

TEI's comments were prepared under the joint aegis of the Institute's Canadian Income and Commodity Tax Committees, whose chairs are John M. Allinotte of Dofasco, Inc., and Glen S. Pye of Nortel Networks Corporation, respectively. Contributing to the development of TEI's comments were David M. Penney of General Motors Corporation, Gary G. Penrose of TransCanada Pipelines Limited, and Alan Wheable of Toronto-Dominion Bank. TEI's comments are reprinted in this issue, beginning at page 64.