CEWS & Income Tax Act Section 125.7: Canadian Tax Lawyer’s Guide

Introduction – The Canada Emergency Wage Subsidy

Many Canadian businesses have been impacted by the ongoing COVID-19 pandemic. While many businesses are experiencing financial hardship, some of them are unable to pay their employee’s wages. In response, the Government of Canada introduced the Canada Emergency Wage Subsidy (CEWS) in April 2020. The CEWS subsidies a portion of an employee’s wages for eligible employers. The purpose of the CEWS is to (1) allow employers to maintain their employees on the payroll during the pandemic; (2) prevent job loss and layoffs; and (3) create new employment opportunities.

Effective April 11, 2020, Canada’s Income Tax Act was amended to introduce the CEWS. The CEWS rules apply by “deeming qualified entities to have overpaid tax and then giving the Minister discretion to refund them [all or part of] the deemed amount.” To be a qualifying entity under subsection 125.7(1) of the Income Tax Act, a Canadian employer must have experienced a reduction in revenues from the average of its revenues in January and February 2020 or from revenues for the same month in the prior calendar year. The deemed overpayment amount is determined using the formula set out in subsection 125.7(2) of the Income Tax Act. Subsection 152.7(3.4) of the Income Tax Act grants the Minister power to, at any time, determine the amount deemed by subsection 125.7(2) of the Act to constitute an overpayment and issue a notice of determination to the employer. Further, subsection 164(1.6) of the Income Tax Act grants the Minister the discretion to refund all or part of the deemed overpayment.

In Iris Technologies Inc. v. R the Federal Court dismissed the Canadian tax litigation lawyer for the Minister of National Revenue’s (the “CRA”) motion to set aside a decision of Prothonotary Kevin Aalto (the “Prothonotary”), who dismissed the Minster’s motion to strike the taxpayer’s, Iris Technologies Inc., application for judicial review of the June 19, 2020 decision, wherein CRA denied Iris’ claims for the CEWS for Periods 1 and 2, and a July 10, 2020 decision, wherein CRA denied Iris’ claim for the CEWS for Period 3. This decision sheds light on the CEWS measures incorporated into the Income Tax Act and the CRA’s discretionary power and limits under these measures. This article provides tax guidance related to the CEWS rules under the Income Tax Act and the Canada Revenue Agency’s (CRA) tax audit of CEWS claims.

The CEWS Eligibility Criteria

Employers that have experienced a decline in revenue due to the COVID-19 pandemic may be eligible for the CEWS to cover a portion of their employee wages, retroactive to March 15, 2020. To be eligible to receive the CEWS, applicants must meet the following criteria:

• Have a CRA payroll account on March 15, 2020:
  • Applicants who did not have a CRA payroll account on March 15, 2020 may still qualify for the CEWS if:
    • Another person or partnership made remittances on their behalf; or,
    • They purchased all (or almost all) of another person’s or partnership’s business assets.
• Be one of the following types of employers:
  • Individuals
  • Corporations or Persons (that are not exempt from Part I of the Income Tax Act)
  • Registered charities
  • Partnerships consisting of eligible employers
  • Specific private organizations
• Have experienced a drop in revenue.

The CEWS Application Process

There are three ways to apply for the CEWS online:

• My Business Account
• Represent a Client
• The CEWS Web Forms application

Applicants must submit a separate application for each CEWS claim for which they are eligible to apply, and for each payroll account they have with the CRA. Generally, CEWS applicants who are registered for direct deposit through their payroll account with the CRA receive the payment within 3 to 8 business days. However, in certain circumstances, CEWS payments may be delayed if additional review (of a CEWS claim) is required or if the CEWS is paid by cheque. It should be noted that only business representatives authorized at level 2 or 3 will be able to apply online under the Represent a Client option.

The CEWS Claim Period

The time frame for each CEWS claim is 4 weeks, beginning on a Sunday. Applicants must confirm their eligibility according to the specific period for which they are applying. The CEWS was introduced in April 2020 with the following claim period:

• Period 1: March 14 to April 11, 2020
• Period 2: April 12 to May 9, 2020
• Period 3: May 10 to June 6, 2020
• Period 4: June 7 to July 4, 2020
• Period 5: July 5 to August 1, 2020
• Period 6: August 2 to August 29, 2020
• Period 7: August 30 to September 26, 2020

Subsequently, the Government of Canada announced its plan to extend the CEWS, as part of its measures to create new jobs and restore employment levels to pre-pandemic. Consequently, the following claim periods were introduced:

• Period 8: September 27 to October 24, 2020
• Period 9: October 25 to November 21, 2020
• Period 10: November 22 to December 19, 2020
• Period 11: December 20, 2020 to January 16, 2021
• Period 12: January 17 to February 13, 2021
• Period 13: February 14 to March 13, 2021
• Period 14: March 14 to April 10, 2021
• Period 15: April 11 to May 8, 2021
• Period 16: May 9 to June 5, 2021
• Period 17: June 6 to July 3, 2021
• Period 18: July 4 to July 31, 2021
• Period 19: August 1 to August 28, 2021
• Period 20: August 29 to September 25, 2021

Iris Technologies Inc. v the Minister

Facts

Iris Technologies Inc. (Iris) is a Canadian corporation that provides telecommunications services to Canadians and abroad. Iris filed applications for the CEWS for periods 1 through 3. Iris reported that its revenues declined in all three periods by 95.92%, 88.57% and 97.08%, respectively, compared to its average revenue earned in January and February of 2020 and “more than the requisite threshold reduction for the same months in 2019”.

Backgrounds

On August 28, 2020, the Canadian tax litigation lawyer for Iris filed a Notice of Application (Application) for judicial review, pursuant to sections 18 and 18.1 of the Federal Courts Act. Specifically, Iris’s Application for judicial review was of the June 19, 2020 decision, wherein CRA denied Iris’ claims for the CEWS for Periods 1 and 2, and a July 10, 2020 decision, wherein CRA denied Iris’ claim for the CEWS for Period 3. On October 2, 2020, the Canadian tax litigation lawyer for the CRA brought a motion seeking to strike Iris’ Application, without leave to amend. CRA’s motion relied on the affidavit of Marie Lusson (the “Lusson Affidavit”) wherein the CRA determined that Iris’ entitlement to the CEWS for Periods 1 through 3 was $0. However, on March 5, 2021, the Prothonotary dismissed CRA’s motion to strike out Iris’s judicial review Application. Subsequently, the Canadian tax litigation lawyer for the CRA filed a motion, on behalf of the CRA, for an order, pursuant to Rule 51 of the Federal Courts Rules, seeking to appeal and set aside the Prothonotary’s March 5, 2021 decision.

Issues

The issues before the Federal Court are as follows: (a) whether the Prothonotary erred in refusing to admit the Lusson Affidavit; and (2) whether the Prothonotary erred in refusing to strike out Iris’ Application for judicial review.

Analysis

The Federal Court held that the “Prothonotary’s conclusions of law are reviewable on a standard of correctness, and his findings of fact or mixed fact and law are reviewable on the standard of palpable and overriding error.”

With respect to the admissibility of the Lusson Affidavit, the Federal Court confirmed that subsection 244(9) of the Income Tax Act “requires that the affiant “has charge” of the appropriate records” and that the Lusson Affidavit “contained no express statement to that effect.” The Federal Court explained that Prothonotary’s decision not to admit the Lusson Affidavit into evidence was because it failed to establish that Ms. Lusson had insufficient “knowledge of the document to support its introduction into evidence.” In addition, the Federal Court held that once the requirements of subsection 244(9) are met, the document in question “is admissible into evidence to establish its nature and contents”. Further, subsection 244(13) of the Income Tax Act may subsequently provide “additional useful purposes surrounding the evidentiary value of the documents.” The Federal Court therefore found “no palpable and overriding error” in the Prothonotary’s decision to decline to admit the Lusson Affidavit into evidence.

With respect to striking Iris’ application for judicial review, the Federal Court structured its reasons into the following four parts: (1) essential nature of the application; (2) CRA’s discretionary power; (3) adequate alternative remedy; and (4) mootness.

The Federal Court agreed with CRA’s position that the Prothonotary’s analysis in context of the essential nature of the application is “reviewable on a standard of correctness.” Upon reading Iris’ Application holistically, the Federal Court explained that the Application “is pleading a sequence of events in support of an assertion that CRA has failed to pay such benefits for improper reasons.” In addition, the Federal Court accepted Iris’ “assertions surrounding the decline in its revenues and its resulting entitlement to CEWS benefits”. The Federal Court also upheld the Prothonotary’s position that Iris’ Application pertains to the Minster’s conduct “in exercising the discretion granted under the COVID-19 measures incorporated into the ITA, which conduct Iris asserts to be procedurally unfair and an abuse of process”. Further, the Federal Court upheld the Prothonotary’s conclusion that Iris’ Application is indeed within the Federal Court’s administrative law jurisdiction”.

With respect to the Minister’s discretionary power under the Income Tax Act, the Federal Court rejected CRA’s position that the Prothonotary has “overstated the scope of the CRA’s discretion” under the Act and has “erroneously found that the application engages a discretionary power on the part of the Minister.” The Federal Court found “no palpable and overriding error” in the Prothonotary’s analysis relating to the Minister’s discretionary power.

In context of adequate remedy, the Federal Court rejected CRA’s submissions relating to the effect of the jurisdictional provision in subsection 18.4 of the Federal Court Act and that the Prothonotary “erred in failing to strike the application.” The Federal Court, however, agreed with Iris’ position that is “consistent with the statutory purpose of the CEWS program, which is to enable Canadian employers to retain employees while coping with the commercial impacts of the COVID-19 pandemic.” In context of adequate remedy, the Federal Court found “no palpable and overriding error on the part of the Prothonotary.”

With respect to mootness, the Federal Court held that since there was no error in the Prothonotary’s decision to refuse to admit the Lusson Affidavit, there is “no evidentiary foundation for the mootness argument.” Therefore, the Federal Court found “no palpable and overriding error” in context of mootness.

Federal Court Decision

CRA’s position for an order pursuant to Rule 51 of the Federal Courts Rules is dismissed.

The Benefits & Concerns Associated with the CEWS

There are ongoing concerns regarding CRA’s audit of CEWS claims and potential repayment. CEWS recipients may have to repay the CEWS if they (i) amend or cancel an application (ii) made a calculation error in their application (iii) receive a notice from the CRA indicating that following a review of their CEWS, their claim has been reduced or denied. Excess CEWS amount received that is not returned to the CRA may be subject to interest. Potential penalties and imprisonment may also apply in circumstances of fraudulent CEWS claims. Further, CEWS recipients who reduce their revenue for the purpose of claiming the CEWS will be required to repay the wage subsidy amount in full, plus a penalty equal to 25% of the total value. Moreover, Iris Technologies Inc. v. R exemplifies how CEWS recipients could potential incur unnecessary legal fees as a result of CRA tax audit into their CEWS claims.

Given the ongoing concerns associated with the CEWS, businesses and organizations should bear in mind that any CRA tax audit, including an audit into a CEWS application, can result in the CRA requesting access to details, including corporate and financial records, that may not be relevant to the CEWS claim as part of a broader tax audit. As such, CEWS applicants should review the relevant eligibility criteria, posted on CRA’s website, prior to submitting their claim. Applicants who notice an error in their CEWS application or in any payment received should contact the CRA immediately to address the error and to confirm their eligibility or consult with an expert Canadian tax lawyer.

Pro Tax Tips – Tax Guidance and CEWS Tax Audit

CEWS recipients who are subsequently found to be ineligible for the wage subsidy can face tax audit and will have to repay the amounts with interest and penalties. If you have questions concerning CRA’s CEWS tax audit, or if you received a letter from the CRA pertaining to a CEWS audit or the repayment of the CEWS and you would like to dispute the CRA’s decision please contact our tax law office for tax guidance from one of our top Canadian tax lawyers.

FAQ

Which employers can apply for the CEWS?

Employers that have experienced a decline in revenue due to the COVID-19 pandemic may be eligible for the CEWS to cover a portion of their employee wages, retroactive to March 15, 2020. To be eligible to receive the CEWS, applicants must meet the following criteria: (1) have a CRA payroll account on March 15, 2020; (2) Have experienced a drop in revenue; and (3) be one of the following types of employers: (i) individuals; (ii) corporations or persons (that are not exempt from Part I of the Income Tax Act); (iii) registered charities; (iv) partnerships consisting of eligible employers; or (v) specific private organizations.

What potential tax consequences may arise if the CRA audits a CEWS application?

Any CRA tax audit, including an audit into a CEWS application, can result in the CRA requesting access to details, including corporate and financial records, that may not be relevant to the CEWS claim as part of a broader tax audit. In addition, CEWS recipients who are subsequently found to be ineligible for the wage subsidy can face tax audit and will have to repay the amounts with interest and penalties. If you received a notice from the CRA relating to any CRA tax audit, including an audit into a CEWS application, please contact our tax law office for tax guidance from one of our top Canadian tax lawyers.