CRA challenged in court cases on capital gains tax hike

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Two salvos have been fired across the Canada Revenue Agency’s (CRA) bow this week in the way of court challenges questioning the taxman’s authority to administer the increase to the capital gains tax, retroactive to June 25, 2024, even though it’s not yet – or may never even become – law. Before reviewing the details of each of the two court challenges, let’s review the background of how we got here.

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The April 2024 federal budget proposed an increase to the capital gains inclusion rate for gains realized on or after June 25, 2024, whereby the inclusion rate was increased to 66.67 per cent, up from 50 per cent. Individuals and certain trusts would still be entitled to the former 50 per cent inclusion rate on the first $250,000 of capital gains annually. Corporations and most family trusts would not.

On June 10, a notice of ways and means motion (NWMM) containing draft legislation to implement the tax change was introduced in Parliament. The next day, the House of Commons voted and agreed upon it, yet no bill to implement the draft legislation was then tabled. On August 12 the Department of Finance released updated legislative proposals relating to capital gains inclusion rate changes.

In September, a second NWMM was tabled in the house, containing revised draft legislation. The house never voted to adopt it. Despite this, in November the CRA announced that while the capital gains tax increase had yet to be formally adopted by Parliament, it would begin administering the capital gains tax as of June 25, 2024.

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Fast-forward to January 6, when the Governor General, on the advice of Prime Minister Justin Trudeau, prorogued Parliament until March 24, such that all unfinished business, including the NWMM, died on the order paper. Shortly after, the CRA published a statement on its website saying that “notwithstanding that Parliament is prorogued, the CRA will continue to administer the proposed capital gains legislation.” It advised that new forms will be available by end of this month, and that arrears interest and penalty relief, if applicable, will be provided for corporations and trusts impacted by these changes that have a filing due date on or before March 3, 2025.

In mid-January, Conservative leader Pierre Poilievre promised to eliminate the increase to the capital gains inclusion rate if elected. This was followed a week later by an announcement from Liberal leadership hopeful and former finance minister Chrystia Freeland who also vowed to scrap the capital gains tax hike if she is elected.

In a C.D. Howe Institute study published last week entitled A Kafkaesque Tax Quagmire: Why We Need to Defer or Abandon the Failed Capital Gains Changes, co-authors Carl Irvine, a tax lawyer and a member of the institute’s fiscal and tax policy council, and John Tobin, a tax partner at Torys LLP, said the federal government’s proposed increase to the capital gains inclusion rate has created “a nightmarish scenario” for Canadians. They argue that taxpayers face a difficult choice: pay at the higher rate now and struggle to recoup overpayments if the measure dies, or follow existing law and risk interest and penalties should it eventually pass.

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The authors called on the government to abandon the proposed increase, or failing that, delay the effective date to at least Jan. 1, 2025, “to spare taxpayers the gamble of filing 2024 returns under a measure that may never pass.”

At least two taxpayers, however, are unsatisfied taking a wait-and-see approach, and are directly challenging the CRA’s authority to administer the tax hike, absent formal parliamentary approval. In separate lawsuits, they are each taking the CRA to federal court.

With all the pressure on the government and the CRA, it’s conceivable that the agency may change its position after this publication deadline. Check financialpost.com for the latest developments.

Debbie Vorsteveld

The first case involves Debbie Vorsteveld, a resident of Mapleton, Ont. She is being represented by the Canadian Taxpayers Federation (CTF) in a test case. Last year, she and her husband sold a property that included a secondary home. They had rented the secondary home to their adult children, but had to sell it when their kids were ready to move on. The CRA says the Vorstevelds must pay higher capital gains taxes under the proposed capital gains increase or face financial penalties.

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The taxpayer is seeking urgent relief from the federal court to block the CRA’s enforcement of the proposed tax increase. In its application, the taxpayer argues the tax increase “violates the rule of law and is unconstitutional.”

As Devin Drover, CTF general counsel, said in a press release, “The government has no legal right to enforce this tax hike because it has not received legislative approval by Parliament. This tax grab violates the fundamental principle of no taxation without representation. That’s why we are asking the courts to put an immediate stop to this bureaucratic overreach.”

Pelco Holdings Inc.

The second challenge involved a corporate taxpayer, Pelco Holdings Inc., which is a private B.C. corporation. The corporation is a shareholder of an engineering firm that has dozens of employees, and operates throughout Western Canada. On Oct. 30, 2024, the corporation realized a capital gain from the sale of certain assets. That gain must be included in the corporation’s income for its taxation year ending Oct. 31, 2024, so the corporation must decide which inclusion rate to use when it files its 2024 return.

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The corporation is being represented by Thorsteinssons LLP, Canada’s largest tax law firm. The federal court application seeks to prevent the CRA from “inappropriately administering the federal Income Tax Act as if the capital gain inclusion rate increase (from one-half to two-thirds) is law.” The application alleges that by seeking to collect more than what is allowed by the Act, the CRA is “contravening the rule of law — a fundamental Canadian constitutional principle that all are subject to the same laws, and, as here, cannot be taxed except in accordance with those laws.”

The taxpayer’s application also states that the CRA’s decision to administer the capital gains hike “places taxpayers in an untenable position. They will be faced with either complying with the law, or complying with the CRA. Either course could lead to significant financial repercussions.”

The taxpayer has appealed to court asking the judge to order the CRA to administer the law as currently written, which taxes capital gains at a 50 per cent inclusion rate, and prevent the CRA from taking any steps to enforce the proposed 66.67 per cent rate. As the application notes, “failure to do so could cause countless Canadians to pay amounts to the CRA which they may never recover.”

Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.

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