Kingstreet and Dunne: Constitutional Tax Law Gets Interesting?
Every lawyer quickly learns to eschew confident statements about what Supreme Court of Canada decisions will mean. You find out early on that the case that seemed to herald an earth-shattering transformation of your field often becomes completely ignored and forgotten, while cases that seemed ho-hum at the time become seminal. The careful solicitor is mindful of Yogi Berra’s advice that prediction is very hard, especially about the future.
But if economic analysis of law has any value at all, then even the most cautious of oracles can see one development coming down the pike. As a result of the Kingstreet Investments Ltd. v New Brunswick (Finance), 2007 SCC 1 [Kingstreet], decision (discussed, with its legislative aftermath, here), we can expect more constitutional tax cases. While other findings of constitutional invalidity won’t get you retrospective damage awards (Guimond v Quebec (Attorney General),  3 SCR 347, Canada (Attorney General) v Hislop, 2007 SCC 10) an unconstitutional tax must (absent remedial legislation) result in full restitution. Given the amount of money at stake, and given the availability of the class action vehicle, there can be no doubt that our most entrepreneurial plaintiff lawyers are boning up on the constitutional principles involved. The overruling of Justice La Forest’s decision immunizing unconstitutional taxes from restitution claims (Air Canada v British Columbia,  1 SCR 1161) will doubtless help sell Professor La Forest’s book.
There certainly are tensions and ambiguities. Under s. 92.2 of the Constitution Act, 1867, the provinces are limited to “Direct Taxation within the Province in order to the raising of a Revenue for Provincial Purposes.” Determining what “Direct Taxation” is has proven difficult. The jurisprudential basis is a distinction in positive economics (between those taxes whose incidence falls on the legal payor and those that do not) which no modern economist believes is valid (since the incidence of tax never falls entirely on the legal payor, and market conditions, not legal form, determine the extent to which it does). The legal test points to an obsolete scientific conception. It’s a bit as though some crucial legal distinction concerning the treatment of chemicals required determining how much phlogiston they contained. Moreover, the policy objectives the courts have pursued when determining whether taxes are direct — maintaining Canada as a free trade area, promoting transparency, allowing for provincial revenue — have no necessary relation with each other, or with the ostensible test. Adding ambiguity in doctrine to the
Most of the constitutional tax jurisprudence focuses on the direct/indirect distinction. However, there is also the phrase “within the Province” to contend with, and it is this phrase that has received some attention from the Supreme Court (Dunne v Quebec (Deputy Minister of Revenue), 2007 SCC 19 [Dunne]). Here too there are both technical rules and broad policy considerations. Where a person, transaction or object of property is located is often a tricky issue for law. In the constitutional tax context, it is especially important that there be limits on a province’s ability to designate a tax source as within its territory, since excessively broad rules create the likelihood of double taxation and taxation without representation. In principle, the rules are designed to prevent the same person, income source or property to be in more than one province. However, as Professor La Forest points out, for the most part, this prevents only unintentional double taxation, since it is very easy for a person in Province A to transact in Province B concerning property in Province C, and each of those provinces can have their bite. Still, the rules governing when a tax is “within the Province” ultimately play an important role in our tax policy and therefore our economic well-being. It is therefore worth taking note of any indication of how the Court is likely to address the issues.
In Dunne, the Court had to consider how much leeway provinces should be given to “deem” income to be earned within their borders. Mr. Dunne is a retired accountant living in Ontario. During his working life, he was a partner in the giant accounting firm of Ernst & Young, which does about 20% of its business in Quebec. Dunne never worked in Quebec. On retirement, he received an allowance based primarily on his years of service and best earnings, but subject to the limit that the total allowances to retired partners would not exceed 15% of gross profits. The Partnership Agreement provided for proportionate reductions in the retirement allowances if their total exceeded this number.
A partnership, unlike a corporation, has no independent legal existence. Its income just is the income of the partners. Therefore, they earn their income wherever the partnership earns it. Active partners of Ernst & Young would therefore uncontroversially earn 20% of their Canadian income in Quebec. On the other hand, people in contractual relationships with Ernst & Young would earn their income where the contract was performed. Ordinary employees in Ontario would earn income, including retirement income, in Ontario.
Section 608 of Quebec’s Taxation Act, CQLR, c I-3, Part 4, deemed someone in the position of Dunne to be a partner, and taxed his retirement allowance like partnership profits. The issue was therefore whether, in doing so, it exceed Quebec’s constitutional tax powers. The Court ruled “yes”:
The partnership agreement itself establishes that Mr. Dunne received a share from the profits of a partnership that carried on a business in the province of Quebec. Under the Taxation Act, the respondent could therefore require the appellant to pay income tax. Under s. 92(2) of the Constitution Act, 1867, this was taxation within the province. The assessment was not based on a legal fiction. The Taxation Act’s deeming provisions, namely ss. 608, 609 and 612.1, operated to determine the portion of the appellant’s income that could be allocated to the partnership’s Quebec activities and the portion of the retirement allowance that could be taxed by the province of Quebec, and did not improperly expand the scope of the provincial taxing power.
There appear to be two possibilities. First, the “deeming” provision could simply state what would otherwise be the case (given the way that Ernst & Young arranged retirement compensation for formerly active partners, the recipients just were partners) or, second, the “deeming” provision could change what would otherwise be the case (had the deeming provision not existed, Dunne’s retirement allowance would just be contractual consideration for past services, calculated with some reference to the partnership’s profits, but not a share in them).
The second interpretation has the wider implications. If it is correct, then provinces have wide constitutional latitude to redefine the legal status of income (and presumably other objects of taxation) to make them come within the province, providing only that they do not engage in “legal fictions.
” If so, then plaintiff lawyers should be frustrated and provincial tax authorities relieved, by the result of this first post-Kingstreet skirmish. But it is early days…