Reasoning in US decision that state tax scheme is unconstitutional could apply in Canada

Canadian tax lawyers analyze applicability to Canada of US Supreme Court decision holding Maryland’s tax scheme unconstitutional
Reasoning in US decision that state tax scheme is unconstitutional could apply in Canada

A United States Supreme Court decision holding that the State of Maryland’s tax scheme was unconstitutional because it didn’t offer credit to residents for taxes paid in other states could also have repercussions in Canada.

“While American jurisprudence is of course not binding on this side of the border, the decision could make it easier to argue, should such a dispute arise, that s. 91(2) of our Constitution should apply similarly and bar a province from taxing income that has been subject to income tax in another province,” says Michael Lubetsky of Davies Ward Phillips & Vineberg in Montréal. “After all, a province is a sovereign entity and can tax what it wants subject to constitutional constraints.”

In the Maryland case, Comptroller v. Wynne, the majority in the 5-4 ruling concluded that the State’s tax credit statute violated the Commerce Clause of the US Constitution. Simply put, a state could not tax its residents on all their income no matter where it was earned.

In Canada, s. 92(2) of the Constitution Act, 1867 grants provinces the power to impose “Direct Taxation within the Province.” Two or more provinces could enact laws that meet that constitutional requirement but also have the effect of imposing double taxation, lawyers believe. For example, Ontario could legally tax all the Canadian income of its residents, while Alberta could tax the income generated by an Ontario resident working in that province. If there were no tax credit system, the Ontario resident would be subjected to double taxation. It’s not clear what recourse, if any, a Canadian taxpayer might have should any such double taxation occur.

A Canadian legal challenge would boil down to whether double taxation by provincial tax authorities interferes with the federal government’s constitutional right to regulate trade and commerce.

For their part, Canadian courts have ruled that the provinces cannot distort international trade, but in cases that dealt with resource taxes, not income taxes.

“Still, it would not take much imagination for a taxpayer to make out a first impression case challenging the constitutionality of double taxation under our trade and commerce clause,” Lubetsky says.

As it turns out, there is no mechanism to resolve double taxation issues that arise between provinces. What does exist is the “Memorandum of Understanding for Avoidance of Double Taxation of Corporations,” which took effect in 2009.

“The memorandum states that a province will not issue an assessment that amounts to double taxation without talking about it,” Lubetsky says. “But if someone withdrew from the agreement, it’s not clear what a taxpayer could do about it.”

It is true that American courts have interpreted the Commerce Clause more widely than Canadian courts have regarded the federal government’s trade and commerce power.

“It would take some development of the jurisprudence for our courts to accept Wynne,” Lubetsky says. “But there’s no case to the contrary and there are sound policy arguments for adopting the US reasoning, which intuitively makes sense.”

But Ted Citrome of Dickinson Wright LLP in Toronto believes that the centralization of income tax administration in Canada is one reason that the double taxation scenario may not arise with any degree of frequency.

“Quebec and Alberta are the only provinces who haven’t ceded the determination of taxes to the Canada Revenue Agency,” he says. “And for the most part the provinces have played nice with each other and have not tried for a cash grab that would put everything out of whack.”

Indeed, there’s been just one reported decision on this issue, a 1939 case in which the Supreme Court of Canada ultimately ruled that a gas tax imposed by Saskatchewan was unconstitutional.

“The issue is more likely to come up in a scenario where a province is overhauling something like its mining or resource regime,” Citrome says.

Even so, Citrome is dubious that a Wynne-based attack would succeed in Canada.

“The US Supreme Court proceeds on that basis that states can’t imposes taxes that discriminate in their impact on interstate commerce or amount to double or multi-taxation, but our Supreme Court has allowed double taxation unless it encroaches on the federal taxation power,” Citrome points out. “So the ultimate question here will be the extent to which provincial action intrudes on what the feds are supposed to be doing.” 

Firm(s)

Davies Ward Phillips & Vineberg LLP