Last week the government confirmed that the prescribed interest rate will remain at one per cent for the third quarter of 2021, which runs from July 1, 2021 to Sept. 30, 2021.
The prescribed rates are set by the Canada Revenue Agency (CRA) quarterly and are tied directly to the yield on Government of Canada three-month Treasury Bills, albeit with a lag.
The calculation is based on a formula in the Income Tax Regulations that takes the simple average of three-month Treasury bills for the first month of the preceding quarter, rounded up to the next highest whole percentage point. As a result, the prescribed rate can never be zero — one per cent is the lowest possible rate.
While the one per cent prescribed rate provides an excellent opportunity for income splitting between a high-income spouse or partner and a lower-income spouse, partner or other family member, including (grand)children, the base prescribed rate is also used to determine the interest rate that is charged on money owed to and from the CRA.
For individuals who are owed money by the CRA, interest compounds at the base rate, plus two percentage points, for a current rate of three per cent. If, on the other hand, you owe the CRA money, the interest rate on tax arrears is the base rate, plus four percentage points, for a total current arrears rate of five per cent.
Given the low interest rate environment we’ve been in for the past decade, the rate charged on overdue taxes has been pretty consistent since the beginning of 2009, fluctuating between five and six per cent depending on the quarter. But in the decade prior, the arrears rate reached as high as 10 per cent.
It’s therefore not surprising that if you’re significantly behind on your taxes, the amount of arrears interest you owe, which, incidentally, compounds daily, can eventually eclipse the taxes you failed to pay in the first instance.
That’s exactly what happened in a recent case involving a Manitoba baker, who was facing a $1.1-million dollar tax bill, more than half of which consisted of arrears interest.
Before reviewing the details of the taxpayer’s quest for interest relief, let’s review the legal process whereby taxpayers can apply for relief.
Waiving interest
If you feel that you were unjustly charged arrears interest on income taxes owing or even penalties, you have the option of applying to the CRA under the “taxpayer relief provisions” of the Income Tax Act.
The CRA has the discretion to cancel or waive either all or a portion of any interest or penalties (but not the actual tax) payable for the 10 previous calendar years if the penalties and interest resulted from circumstances beyond the taxpayer’s control. These can include extraordinary circumstances, such as natural disasters, a serious illness or accident or serious emotional or mental distress such as a death in the family.
They can also include interest charged resulting primarily from CRA actions, such as processing delays that result in taxpayers not being informed (within a reasonable time) that an amount was owing, errors in CRA material which led a taxpayer to file a return based on wrong information, incorrect information provided to a taxpayer by the CRA, and processing errors. Finally, the CRA will also consider financial hardship and an inability to pay.
If your request for relief is turned down by the CRA, you can request a review by a second CRA official. If your request is again rejected, you can apply to the Federal Court for a judicial review.
The court will determine whether the CRA “exercised its discretion in a reasonable and fair manner,” with the power to send it back to the CRA, once again, for reconsideration by a new officer.
The case
The federal court case, held recently via videoconference, involved a taxpayer who owned a popular Manitoba bakery and who was charged with tax evasion in 2009. He pleaded guilty to multiple charges and was penalized $178,965. He also had to pay back nearly $300,000 in federal income taxes and roughly $150,000 in provincial taxes.
The CRA discovered that the taxpayer had understated sales from his bakery by more than $1 million on its corporate tax returns from 2003 to 2007. He also failed to report nearly $750,000 in personal income from 2002 to 2007.
The taxpayer appealed to the Federal Court to ask the judge to review the CRA’s decision to deny his request to waive or cancel interest incurred from 2008 to 2018 on his outstanding tax debts for the 2002 through 2007 taxation years. As of May 15, 2019, he owed $1,161,010, of which $632,120 related to interest charged on unpaid taxes.
The taxpayer’s initial request for relief was on the basis of financial hardship, inability to pay, and serious illness, and was made on April 12, 2018, but it was refused. He asked the CRA to reconsider that decision, but on July 23, 2019, this was also denied.
Among various arguments presented in court, the taxpayer submitted that the CRA failed to consider the unfairness inherent in the “inordinate and disproportionate” amount of interest compared with the underlying tax debt.
As he pleaded, “The sheer magnitude of interest in proportion to the underlying tax is inherently unfair and warrants relief under the fairness provisions.”
But the judge felt that the proportion of interest accrued to the underlying tax debt is not a “standalone consideration,” absent other factors. In this case, the CRA found that the taxpayer had sufficient assets to rearrange his financial affairs in order to pay his tax debt.
The record before the CRA showed that the taxpayer had assets valued at over $415,000, with a mortgage liability of $48,000 on a primary residence valued at $375,000. In addition, he was due to receive an insurance payment of $541,000 as a result of a fire that destroyed the bakery in the spring of 2018.
The judge was unable to conclude that the CRA’s decision to deny interest relief was unfair, writing: “In my assessment, the decision-maker considered all of the evidence before her that may have affected the ability of (the taxpayer) to pay the accrued interest.”
The judge dismissed the appeal, effectively upholding the arrears interest owing.