Date:
20090417
Docket: A-293-08
Citation: 2009 FCA 117
CORAM: LÉTOURNEAU
J.A.
NADON
J.A.
PELLETIER
J.A.
BETWEEN:
ADP CANADA CO.
(SUCCESSOR TO CANADIAN
AUTOMATIC DATA PROCESSING
SERVICES LTD.)
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
LÉTOURNEAU J.A.
Issue
[1]
Did
Archambault J. of the Tax Court of Canada (judge) err in finding that the $1.1
billion in funds received by the appellant (ADP) should be included in its
“taxable capital” and “taxable capital employed in Canada” as an advance under paragraph 181.2(3)(c)
of the Income Tax Act (Act)? The taxation year in issue is 2001.
[2]
For the
reasons that follow, I believe that the judge erred and therefore his decision
cannot stand and should be reversed.
[3]
Before I
address the issue raised in this appeal, I need to provide the relevant
legislation and some background information.
The relevant legislation and the nature
of the tax at issue
[4]
Paragraph
181.2(3)(c) reads:
|
181.2 (3) Capital – The capital of a corporation
(other than a financial institution) for a taxation year is the amount, if
any, by which the total of
(a)
the amount of its capital stock (or, in the case of a corporation
incorporated without share capital, the amount of its members’
contributions), retained earnings, contributed surplus and any other surpluses
at the end of the year,
(b)
the amount of its reserves for the year, except to the extent that they were
deducted in computing its income for the year under Part I,
(b.1)
the amount of its deferred unrealized foreign exchange gains at the end of the
year,
(c)
the amount of all loans and advances to the corporation at the end of the
year,
|
181.2(3) Capital – Le capital d’une société,
sauf une institution financière, pour une année d’imposition correspond à
l’excédent éventuel du total des éléments suivants :
a) le capital-actions de la société (ou, si
elle est constituée sans capital-actions, l’apport de ses membres), ses
bénéfices non répartis, son surplus d’apport et tout autre surplus à la fin
de l’année;
b) ses réserves pour l’année, sauf dans la
mesure où elles sont déduites dans le calcul de son revenu pour l’année en
vertu de la partie I;
b.1) ses gains sur change non réalisés reportés
à la fin de l’année;
c) les prêts et les avances qui lui ont été
consentis à la fin de l’année;
|
[Emphasis added]
[5]
The tax levied pursuant
to the above paragraph was a temporary tax imposed on the corporate sector to
help reduce the federal deficit: see Budget Papers, tabled in the House
of Commons, April 27, 1989, by the Department of Finance Canada, at page 40. It applied to large corporations that had
financial resources in excess of $10,000,000 to carry on their activities. The
tax was abolished in 2005.
Facts and Procedural History
[6]
ADP is a corporation
whose business is to provide its clients with integrated payroll and payroll
tax services for a fee. ADP pays, on behalf of its clients, the latter’s
employees as well as the statutory remittances with respect to those employees.
In other words, instead of setting up their own payroll department, ADP’s
clients contract out this service to ADP. For the taxation year ending June 30,
2001, ADP’s earned payroll-processing fees totaled $130,520,848.
[7]
ADP’s clients are
required to provide the sums due in advance to ADP so that ADP can process and
transfer them to the clients’ employees and the tax authorities on the due date
specified in the contract for services. Up to 48 hours prior to the initiation
by ADP of any correlating payroll distribution to its clients’ employees,
clients must provide ADP with all amounts associated with their payroll,
including the relevant service fees, plus any withholding taxes to be remitted
on the clients’ behalf to the relevant taxing authorities.
[8]
The amount of
salaries and withholding taxes (the Funds) sent to ADP by its clients are kept
in a separate account reported as Funds held for clients until transferred to
the employees or the tax authorities. ADP’s transfer obligations are referred
to as the Client Funds Obligations Account.
[9]
In the taxation year
2001, ADP processed $83 billion on behalf of its clients. At the end of June
2001, ADP reported a balance of $1,104,129,044 as Client Funds Obligations in
its financial statements.
[10]
Under its contract
for services, ADP was authorized to invest the Funds received from and held for
clients until they were transferred to the clients’ employees or the tax
authorities. Because there was a continuous flow of Funds transferred in and
out of ADP’s clients’ accounts, ADP enjoyed the benefit of approximately $500
million as a permanent source of sums to invest. The return in the nature of
interest on the investment of these sums for the year 2001 amounted to
$57,089,700.
[11]
In the reassessment
dated January 7, 2005, the Minister of National Revenue (Minister) added to
ADP’s taxable capital the $1.1 billion reported by ADP as Client Funds
Obligations in its June 30, 2001 financial statements. The addition was made
pursuant to and for the purposes of Part I.3 of the Act.
[12]
As a result of the
increase that he made to ADP’s taxable capital, the Minister disallowed to ADP
a carry back of unused surtax credit of $140,759 in the computation of its tax
payable under Part I.3 of the Act for its taxation year ending June 30, 1999.
[13]
Because of and as a
corollary to the conclusion that I have reached on this appeal, ADP is entitled
to that surtax credit. The judgment will reflect such entitlement.
[14]
I have summarized in
a nutshell the key facts necessary to dispose of this appeal. Before the Tax
Court, the hearing proceeded on an agreed statement of facts. For the sake of
completeness, I reproduce a more elaborate portion of the relevant facts as
they are found in paragraph 2 of the judge’s reasons for judgment:
…
6. The Appellant carries on a
business under which it provides its clients with an integrated payroll and
payroll taxes services for a fee (the “payroll‑processing fees”).
7. The duties and obligations
of the Appellant and its clients are setout [sic] in an agreement signed
by each party.
8. The Appellant pays, on
behalf of its clients, to their employees, their salaries and pays, to the
tax authorities, the withholding taxes relating to those salaries.
9. The obligation to pay the
salaries and to make the applicable withholding tax remittances to the tax
authorities is an obligation of the clients of the Appellant, not the
Appellant’s own legal obligation.
10. The contractual
obligation of the Appellant toward its clients is limited to the payroll
services, including the payment of the salaries to its Clients’ employees and
the payment of the applicable withholding tax remittances to the tax
authorities made on behalf of its clients.
11. The only remuneration
paid to the Appellant by its clients is the payroll‑processing fees.
12. For the taxation year
ended June 30th, 2001, the Appellant earned payroll‑processing
fees for a total amount of $130,520,848.
13. In addition to processing
its clients’ payroll data (i.e. calculating the amount of wages owed by
its clients to their employees as well as the amount of withholding taxes its
clients are obligated to remit to the relevant taxing authorities), the
Appellant’s payroll and tax filing services also include the making of actual
payments, on behalf of its clients, to its clients’ employees and to the tax
authorities.
14. Such payments are
initiated or drawn from the Appellant’s bank accounts, not from its
clients’ bank accounts.
15. In the course of its
payroll services business, the Appellant collects funds from its clients to pay
their employees on their respective paydays and to pay, to the relevant tax
authorities, the withholding taxes relating to those salaries.
16. The Appellant’s clients
are required to pay in advance to the Appellant, up to 48 hours
prior to the initiation by the Appellant of any correlating payroll payments to
its clients’ employees, all amounts associated with their payroll, including
the relevant payroll‑processing fees, plus any withholding taxes that are
to be remitted on their behalf to the respective tax authorities.
17. Those amounts are held
by the Appellant for a period of 3 to 45 days before payment of the
salaries and the appropriate withholding taxes to the tax authorities,
depending on the remittance deadline provided for each client.
18. Those amounts provide
partial protection to the Appellant regarding potential funding breaches by
clients in respect of subsequent payrolls.
19. A portion of each payment
made to the Appellant by its clients represents an amount to be paid to certain
tax authorities that do [sic] not become due until some time after the
pay date in question. However, for matters of simplicity, clients pay the
Appellant all amounts applicable to a particular payroll at one time.
20. The amounts of salaries,
withholding taxes and payroll‑processing fees paid to the Appellant by
its clients are kept in separate account of the Appellant until paid to
the employees, paid to the tax authorities or earned by the Appellant, as the
case may be.
21. Those pre-funded amounts
are referred to in this Amended Partial Agreed Statement of Facts as the “Funds
Held for Clients” and the Appellant’s respective obligations toward its
clients are referred to as the “Client Funds Obligations”.
22. Whenever the Appellant
receives an amount from its clients for the payment of its payroll and
appropriate withholding taxes, the Client Funds Obligations account is credited
by the amount received and the Funds Held for Clients account is debited by the
same amount.
23. Whenever the Appellant
pays salaries and thereafter makes withholding tax remittances to tax
authorities on behalf of its clients, the Client Funds Obligations account is
debited by the amount paid by the Appellant and the Funds Held for Clients
account is credited by the same amount.
24. Whenever the payroll‑processing
fees paid to the Appellant by its clients are earned by the Appellant, the
Client Funds Obligations account and the Bank account are debited by the
amount earned and the Funds Held for Clients account and the Revenue account
are credited by the same amount.
25. In its trial balance for
the fiscal period ended June 30th, 2001, the Appellant reported a
debit balance of $1,104,129,044 in the Funds Held For Clients account and a
credit balance of the same amount in the Client Funds Obligations account.
26. Of the amount shown as
Client Funds Obligations in the Appellant’s June 30th, 2001, trial
balance, only the portion relating to the payroll‑processing fees payable
to the Appellant was eventually recognized as income for accounting and tax
purposes.
27. It is the amount of $1,104,129,044
reported as Client Funds Obligations in the Appellant’s June 30th,
2001, trial balance that the Minister added, by reassessment dated
January 7th, 2005, to the Appellant’s “capital”, “taxable
capital” and “taxable capital employed in Canada” for the purposes of the
application of subsection 181.1(1) of the ITA to the Appellant’s
taxation year ended June 30th, 2001.
28. As of June 30, 2001, the
Appellant held in the Funds Held for Clients account the following amounts on account
of the fees payable by its clients that were earned and recognised as income
for income tax purposes but not yet transferred to its bank account:
|
Fees
|
$4,583,744.78
|
|
GST and HST
|
335,247.97
|
|
QST
|
89,414.33
|
|
Total
|
5,008,407.08
|
29. As a result of the
increase mentioned in paragraph 27 of this Amended Partial Agreed
Statement of Facts, made by the Minister, to the Appellant’s “capital”,
“taxable capital” and “taxable capital employed in Canada”, the Minister
disallowed, by reassessment dated January 7th, 2005, to the
Appellant a carry back of unused surtax credit of $140,759 in the computation
of its tax payable under Part I.3 of the ITA, for its taxation year
ended June 30th, 1999.
30. The amounts included by
the Appellant in the Funds Held for Clients account as of June 30, 2001, were
in respect of salaries and withholding tax remittances to the tax authorities
that were payable after June 30th, 2001, and payroll‑processing
fees earned by the Appellant but not yet transferred to its bank account.
31. The amounts of the Funds
Held For Clients and the Client Funds Obligations accounts were not reported in
the Appellant’s balance sheet for its fiscal period ended June 30th,
2001, filed with its 2001 tax return.
32. The financial statements
filed by the Appellant with its 2001 tax return were not audited but included a
“Notice to Reader”. No notes to the financial statements were attached.
33. According to the
generally accepted accounting principles, the Appellant’s Funds Held For
Clients and Client Funds Obligations accounts should have been disclosed as an
asset and a liability, respectively, in its financial statements or
in a note attached to those financial statements.
34. The Appellant’s payroll
services business is similar to the payroll services businesses of its sister
companies.
35. The consolidated balance
sheet of the Appellant’s US parent company, namely Automatic Data Processing,
Inc., filed with its 2001 Annual Report, reported as an asset and as a
liability the “Funds Held For Clients” and “Client Funds Obligations” accounts,
respectively, of the Appellant’s sister companies.
36. The US
Securities and Exchange Commission specifically requested that the “Funds Held
For Clients” and “Client Funds Obligations” accounts be treated by the
Appellant’s parent company as an asset and a liability, respectively, in its
financial statements.
37. The Appellant’s Funds
Held For Clients and Client Funds Obligations accounts are now disclosed as an
asset and a liability, respectively, in the Appellant’s financial statements
since 2002.
38. The Appellant invests,
primarily in fixed‑income instruments (mostly cash equivalents and
marketable securities), the amounts included in the Funds Held For Clients
account.
39. The interests [sic]
on such investments are recognized by the Appellant in its revenues as
earned.
40. Such interests [sic]
amounted to $57,089,700 in the Appellant’s fiscal period ended June 30th,
2001.
41. In its financial
statements for its fiscal period ended June 30th, 2001, the
Appellant’s [sic] reported income before taxes of $30,280,238.
42. In its fiscal period
ended June 30th, 2001, the Appellant paid, to a related US
company, fees of $1,168,063 to manage the amount included in the Funds Held For
Clients account.
43. The contracts entered
[into] by the Appellant and its clients provide that when the Appellant is
responsible for missing the withholding tax remittance statutory deadline,
the Appellant shall be responsible for any penalty and interest payable related
to late remittance to the tax authorities.
44. In the course of the
payroll services provided by the Appellant, withholding tax remittances made on
behalf of its clients were occasionally made by the Appellant past the
statutory deadline.
45. In its fiscal period
ended June 30th, 2001, the Appellant paid $397,929 of penalties
and interest with respect to late withholding tax remittances made on
behalf of its clients.
46. Such penalties and
interest were paid by the Appellant in the normal course of doing business.
47. The Appellant claimed a
deduction of this amount of $397,929 in computing its business income for its
taxation year ended June 30th, 2001.
48. By reassessment dated
January 7th, 2005, the Minister of National Revenue disallowed this
deduction of $397,929.00.
[Emphasis added by the judge]
The decision of the Tax Court of Canada
[15]
In coming to his
conclusion, the judge relied heavily on an earlier decision that he had
rendered and which was affirmed by our Court: see Oerlikon Aerospatiale Inc.
v. Canada, [1997] DTC 962, [1999] DTC 5318.
[16]
With respect, the
decision in Oerlikon is of no assistance in the present instance because
it was not disputed in that case that the amounts included by the Minister in Oerlikon’s
capital for Part I.3 tax purposes were “advances”. The taxpayer argued that the
advanced funds, which were on account of its future income, were not “advances”
within the meaning of Part I.3 of the Act because it was of the view that the
term “advance” in paragraph 181.2(3)(c) meant only “advance in the sense
of a loan”. The taxpayer argued therefore that the paragraph contemplated a lender-borrower
relationship. In the present instance, the crux of the matter bears on whether
the Funds at issue are “advances” or not within the meaning of the paragraph. I
will come back to the Oerlikon decision when reviewing a specific
finding made by the Tax Court judge.
[17]
The Act provides no
definition of the term “advance”. As he did in the Oerlikon case, the
judge relied upon financial, accounting and ordinary dictionaries. He saw as
the common thread in the ordinary definitions of “advance” the fact of paying
an amount before it is due: see paragraph 17 of the judge’s reasons for
decision.
[18]
Referring to an
accounting dictionary, he accepted the following two definitions: “Amount paid
to a person to enable him to make expenditures for which he will have to
account at a later date” and “Amount to be applied against the price of a
contract, services or goods, paid before the contract is performed, the
services rendered or the goods delivered”: ibidem at paragraphs 9 and
17.
[19]
Finally, in coming to
his conclusion, the judge took comfort in the fact that ADP had the right to
invest the Funds and to retain the interests generated thereby. He also
attached great significance to the fact that the interest became an integral
and important part of ADP’s business without which ADP would have suffered a
loss: see paragraphs 19 to 21 of his reasons for judgment.
Analysis of the decision of the Tax Court and the
submissions of the parties
[20]
ADP was engaged in
contracts for services with many clients. As previously mentioned, its
obligations under these contracts were to ensure that the salaries due to the
clients’ employees and the taxes owed to the fiscal authorities would be paid
and paid on time. The nature of the services to be rendered by ADP involved the
transfer of Funds by the clients to ADP and the processing and conveying of
these Funds by ADP to third parties. I think the nature of the services and the
fact that the services involved sums of monies was the source of the confusion.
If the goods to be transferred by ADP to third parties were cars, for example,
no one would have said that the cars or the value of these cars were advances
to ADP. There has been in my view some confusion between the services to be
rendered by ADP and the payments due by ADP’s clients for these services.
[21]
With this in mind,
the time has come to examine the definitions of “advance” upon which the judge
founded his decision.
a)
Whether the $1.1 billion was a payment made before it was due
[22]
The short answer to
this question is that the $1.1 billion is not what was due to ADP. What were
due to ADP were the fees for the processing services rendered by ADP. The $1.1
billion is simply not an advance on the $130 million paid in fees for the
processing services.
[23]
Counsel for ADP
addressed this definition of advance found and used by the Tax Appeal Board in Crassweller
v. Minister of National Revenue, 49 DTCI, at page 18, referred to by the
judge in paragraph 9 (footnote 9) of his reasons for judgment:
…or something paid to a person before the
time at which the payor becomes liable to make a payment to such
person which later payment would be reduced by the amount of the advance
and thus cancel any liability of the recipient to repay the advance.
[Emphasis added]
He
submits that this passage in the Crassweller decision was misconstrued
and misapplied by the judge and by counsel for the respondent. I agree.
[24]
If a transposition of
the underlined words is made in the present instance, the excerpt then reads:
…or something paid to
ADP before the time at which the client becomes liable to make a
payment to ADP which later payment would be reduced by the amount of the
advance and thus cancel any liability of ADP to repay the advance.
[Emphasis added]
[25]
The only debts that
the clients had towards ADP were the fees for the contract for services. The
$83 billion, of which the $1.1 billion in issue was part, were debts that the
clients had towards their employees and the fiscal authorities. The Funds were
for the payments of these debts by the debtors, i.e. ADP’s clients. ADP was
merely facilitating the payments by the debtors of their debts. It was not the
creditor of the Funds due and, therefore, these Funds could not have been an
advance paid to ADP.
b) Whether the $1.1 billion
was an amount to be applied against the price of a contract or a service, paid
before the contract is performed or the service is rendered
[26]
Without further repetition,
it is clear that the only payments due to ADP on account of the services to be
rendered are the fees stipulated in the contract for services. It is also quite
clear that the $1.1 billion bears no relationship with the price of the
contract and consequently is not an advance on the contract.
c) Whether the $1.1 billion
was an amount paid to ADP to make expenditures for which it will have to
account at a later date
[27]
I do not think there
can be any doubt that the $1.1 billion is an expenditure of the clients of ADP,
not an expenditure of ADP which acted as a mere conduit in ensuring that the
amounts due to the clients’ employees for salaries and the fiscal authorities
for taxes are transferred on time to the intended recipients. Not surprisingly,
no such expenditure is claimed by ADP in its financial statements of 2001 and
2002: see appeal book at pages 142 to 149.
[28]
It cannot be said
that the $1.1 billion is an expense incurred by ADP in rendering to its clients
the services provided for in the contract for services. Indeed, the transfer of
the $1.1 billion to third parties is the very service to be rendered by ADP
under its contract. This, in my view, also answers the respondent’s contention
that the $1.1 billion could be seen as a disbursement by ADP. If it is to be
considered as a disbursement, it is undoubtedly one incurred by ADP’s clients.
d) Whether the interests gained
from an investment of the Funds and used as a financial resource by ADP changed
the legal nature of these Funds
[29]
In considering the
fact that the Funds could be invested by ADP to its benefit, the judge referred
at paragraph 11 of his reasons for judgment to the following excerpt from the
decision of this Court in Oerlikon:
[11] Justice Noël added at paragraph 32:
[32] The effect of an advance be it
in the sense of a payment on account or a loan, is to make the amount
of money it represents available to the person or corporation which
receives it. In the instant case, the advances were an integral part of the
financial resources available to the appellant at the end of its 1989
fiscal year according to the financial statements it filed, and nothing either
in the legislation or the tax policy which led to its enactment indicates that
Parliament intended to exclude advances from the tax under Part I.3.
[Emphasis added by the judge]
[30]
Later on, at
paragraphs 21 and 22 of his reasons, the judge emphasized the significance of
the financial resources obtained from the investment of the Funds to conclude
“that the $1.1 billion constitutes advances referred to in the definition of
“capital” in paragraph 181.2(3)(c) of the Act”.
[31]
I reproduce the two
paragraphs:
[21] Although strictly speaking, there is no
requirement in that regard, it is comforting to realize that the $1.1
billion in advances existing at the end of the 2001 taxation year did indeed
represent a significant financial resource available to ADP. The advances
received during the entire course of the year allowed ADP to earn more than $57
million in interest, which represented 28% of its gross revenue. As pointed
out by counsel for the Minister, without this interest earned from the advanced
funds, ADP would have incurred a loss. This was indirectly acknowledged by
Mr. Surminsky, who testified that had it not been allowed to invest the
advances made available to it in contemplation of the payment of its clients’
obligations with regard to salaries and government remittances, ADP would have
been required to modify its business model and increase its fees.
[22] Finally, it is worth noting that the
balance sheet for ADP for the year ended June 30, 2001, shows a capital stock
of $3.8 million and retained earnings of $18.6 million. So the advances from
ADP’s clients, which are described in its accounting records as Funds Held for
Clients and Client Funds Obligations in its accounting records and which
amounted at the end of its 2001 fiscal year to $1.1 billion, do constitute a
significant asset and liability at the end of its taxation year. Mr.
Surminsky also stated that a core amount of $500 million was a more or less
permanent asset and liability of ADP. In his argument, counsel for ADP also
contended that these funds allowed ADP to make long term investments, although
this fact had not necessarily been put into evidence. Therefore, I do not
have any doubt in concluding that the $1.1 billion constitutes advances
referred to in the definition of “capital” in paragraph 181.2(3)(c) of
the Act.
[Emphasis added]
[32]
To the extent that
the judge concluded that the Funds were ‘advances” because they turned out to
represent a significant financial resource available to ADP, this conclusion is
erroneous.
[33]
In Oerlikon,
in the above passage cited by the judge, this Court was considering the effects
of an advance, one of which was to make the monies the advance represents
available to the recipient. This Court had already found that it was an
advance. This Court did not use the fact that the recipient was using the
monies received as a financial resource as a basis for concluding that these
monies were an advance. This Court neither confused nor conflated the cause and
the effect.
Conclusion
[34]
Under a contract for
services, ADP acted as a facilitator and a conduit to ensure that the sums due
by its clients to their employees and to the fiscal authorities were paid on
time. The nature of the services provided by ADP implied the processing and
transfer of the clients’ Funds to those to whom they were due and who were the
intended recipients. The Funds were the goods to be transferred. They were not
“advances” to ADP because they were neither a payment made to ADP before it was
due, nor an amount to be applied against the price of the service, paid before
the service is rendered, nor an amount paid to ADP for an expenditure of ADP.
[35]
For these reasons, I
would allow the appeal with costs and set aside the decision of the Tax Court
of Canada. Proceeding to render the judgment that should have been rendered, I
would allow with costs the appeal of the appellant in the Tax Court of Canada
and refer to the Minister:
a) the Notice of
Assessment issued for the 2001 taxation year for reconsideration and
reassessment on the basis that the amount of $1,104,129,044 must not be
included in the capital of ADP under section 181.2 of the Act; and
b) the Notice of
Assessment issued for the 1999 taxation year for reconsideration and reassessment
on the basis that the amount of surtax credit of $140,759 must be allowed.
“Gilles
Létourneau”
“I
agree
M.
Nadon J.A.”
“I
agree
J.D.
Denis Pelletier J.A.”
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