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Testifying Before the House of Commons Standing Committee on Finance

On November 25, 2013, I had the privilege of travelling to Ottawa to appear before the House of Commons Standing Committee on Finance to discuss certain aspects of Bill C-4, the second implementation act for measures proposed in the 2013 federal budget, as well as other measures.  Bill C-4 is at the second reading stage.  The Committee’s work on Bill C-4 began earlier in the month with testimony from government officials.  My task, from a practitioner’s point of view, was to address those provisions that close loopholes in the Income Tax Act.

I read my opening statement (each witness is limited to a five-minute opening) and answered a few questions.  I fielded questions from two members of the Committee (Mark Adler of the Conservatives and Murray Rankin of the NDP who happens to be a fellow graduate of the University of Toronto Faculty of Law and an accomplished litigator).  Both Mr. Adler and Mr. Rankin, along with the other members of the Committee, went out of their way to make me feel welcome.  Much of the time was taken up by a spirited discussion of the proposal to phase out tax credits for investors in Labour Sponsored Venture Capital Corporations (which appear to be predominantly located in the province of Quebec).  The entire meeting was recorded and transcribed.

Around the dinner hour, the Minister of Finance, Hon. Jim Flaherty, appeared before the Committee to describe some of the more important provisions of Bill C-4 and to answer questions from members of the Committee.  Hon. Scott Brison participated in a lively exchange with the Minister.

It was certainly a long day for members of the Committee and their staff.  They prepared for the meeting in the morning and participated in the proceedings from 3:30 p.m. until after 8:30 p.m. - and this was only one of a number of intensive sessions devoted to the close study and consideration of Bill C-4.  I look forward to tracking the progress of Bill C-4 through the House of Commons Standing Committee on Finance as well as the Senate Committee on National Finance.  If everything proceeds according to plan, Bill C-4 may very well become law before the end of the year.

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Testifying Before the House of Commons Standing Committee on Finance

What Kind of Appellate Lawyer was Justice Roberts?

I first heard of John Roberts Jr. when he was nominated to the United States Supreme Court as Chief Justice.  I watched the coverage on C-SPAN which replayed a seminar that he gave to a group of law students on advocacy.  I was quite impressed – but not as impressed as I was after reading this article from The American Lawyer magazine.  Appellate advocates have much to learn from the Chief Justice of the United States:

http://www.americanlawyer.com/PubArticleTAL.jsp?id=1202620317367

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What Kind of Appellate Lawyer was Justice Roberts?

Federal Court of Appeal strikes out a pleading alleging that expenses are non-deductible in light of “egregious and repulsive” conduct by a taxpayer

In a ruling handed down May 6, 2013, the Federal Court of Appeal ordered that portions of a Crown pleading be struck out for suggesting that a deduction may be disallowed on the basis that the conduct of the taxpayer in incurring the expense was “egregious or repulsive”.  Sharlow J. A. wrote the reasons in Canadian Imperial Bank of Commerce v. The Queen, 2013 FCA 122 in which Evans J.A. and Stratas J.A. concurred.

By way of background, the Canada Revenue Agency reassessed CIBC to disallow the deduction of some $3 billion of expenses incurred between 2002 and 2006.  The expenses at issue were incurred to settle litigation in the United States arising from losses suffered due to the collapse of Enron Corporation.  In the U.S. litigation, it was alleged that CIBC participated in the financing of Enron in a manner that made it liable to the complainants.

The Income Tax Act provides the formula for determining a taxpayer’s income for the year for income tax purposes.  Under paragraph 3(a), one component of a taxpayer’s income is income from a business of the taxpayer.  Under subsection 9(1), a taxpayer’s income for a year from a business is the taxpayer’s profit for the year from that business.

The most important limitation on the scope of subsection 9(1) is paragraph 18(1)(a) which provides:

18. (1) In computing the income of a taxpayer from a business […] no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business […];

In 65302 British Columbia Limited v. The Queen, a 1999 decision in which the deduction of a fine was allowed (later to be specifically disallowed by Parliament), Iacobucci J. of the Supreme Court of Canada made the following observation:

It is conceivable that a breach [of the law] could be so egregious or repulsive that the fine subsequently imposed could not be justified as being incurred for the purpose of producing income.

In the contentious part of its pleading, the Crown relied on that obiter statement and offered the following theory of non-deductibility of expenses:

134. The misconduct of [CIBC and its affiliates] was so egregious and repulsive that any consequential settlement payments […] cannot be justified as being incurred for the purpose of gaining or producing income from a business or property within the meaning of paragraph 18(1)(a) of the [Income Tax] Act. The [CIBC affiliates] knowingly aided and abetted Enron to violate the United States’ federal securities laws and falsify its financial statements. The misconduct of [the CIBC affiliates] in enabling Enron to perpetrate its frauds, known to [CIBC], or the misconduct of [CIBC] itself, was so extreme, and the consequences so dire, that it could not be part of the business of a bank.

The Crown’s contention, in a nutshell, was that an expense incurred due to conduct of the taxpayer that was “egregious or repulsive”, is precluded from deduction by paragraph 18(1)(a) of the Income Tax Act.

The CIBC asked the Tax Court of Canada to strike out that paragraph along with the other portions of the pleading reflecting the same theory.  The Tax Court chose not to do so.  The Federal Court of Appeal disagreed and struck out the contentious paragraph along with the related parts.

In dismissing the Crown’s argument, the Federal Court of Appeal emphasized that “the only question to be asked in determining whether paragraph 18(1)(a) prohibits a particular deduction is this: Did the taxpayer incur the expense for the purpose of earning income?”  The Court concluded by stating that the characterization of the morality of a taxpayer’s conduct is not legally relevant to the application of paragraph 18(1)(a) of the Income Tax Act.

Parties are generally given the opportunity to make whatever arguments they consider necessary to their case with the ultimate determination being made by the trial judge who is in the best position to decide questions of relevance and weight in light of all the evidence.  It is rather unusual for a legal theory, novel though it is, to be taken off the table at such an early stage.  At the same time, courts are increasingly concerned about “proportionality” and are reluctant to allow scarce judicial resources to be spent on matters that are unlikely to have any effect on the outcome of the hearing.  Whatever one’s view of the matter the Crown rarely seeks leave to appeal on procedural points, making it unlikely that this decision will be reviewed by the Supreme Court of Canada.

Notwithstanding the decision of the Federal Court of Appeal, the Crown will still be able to argue that the deductions taken by CIBC ought to be disallowed on a variety of other grounds including:

  • the deduction of the settlement payments does not accord with well accepted business principles;
  • the settlement payments were not made for the purpose of earning income from a business;
  • the settlement payments were outlays on account of capital;
  • the settlement payments were contingent liabilities when made; and
  • the amount of the settlement payments were not reasonable in the circumstances.

Although the taxpayer has prevailed in this battle, the war has just begun.

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This article was first published in the International Tax Review.

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Federal Court of Appeal strikes out a pleading alleging that expenses are non-deductible in light of “egregious and repulsive” conduct by a taxpayer

Rulings and GAAR to be Featured at the Toronto Centre CRA & Professionals Group Breakfast Meeting – June 6, 2013

The June 6th breakfast meeting of the Toronto Centre CRA & Professionals Group promises to be particularly informative. It features presentations from senior Ottawa CRA officials on the work of the Rulings Directorate and the CRA’s administration of the General Anti-Avoidance Rule. This is in addition to the case comments provided by Cliff Rand of Deloitte Tax Law LLP and Arnold Bornstein of the Department of Justice.

Please click here to register for the June 6th breakfast meeting.

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Rulings and GAAR to be Featured at the Toronto Centre CRA & Professionals Group Breakfast Meeting – June 6, 2013

Judicial review applications challenging Minister’s alleged violation of Voluntary Disclosure Policy and MAP agreement allowed to proceed: Sifto Canada Corp. v. MNR

In Sifto Canada Corp. v. Minister of National Revenue, 2013 FC 214, Prothonotary Aalto of the Federal Court rejected the Crown’s motion to strike out judicial review applications filed by Sifto Canada Corp. challenging decisions made by the Minister of National Revenue to:

(a) assess penalties contrary to the terms of the Voluntary Disclosure Program; and

(b) assess transfer pricing adjustments contrary to an agreement between the Competent Authorities of Canada and the United States on the appropriate transfer price under Article XXVI of the Canada-U.S. Tax Treaty (known as the “Mutual Agreement Procedure” or “MAP”).

The Crown made the usual argument that section 18.5 of the Federal Courts Act precludes such judicial review applications (for background, see our earlier post on the JP Morgan decision mentioned below).  Prothonotary Aalto had this to say about the Crown’s argument:

[8]    One of the mantras of the Minister of National Revenue is that the judicial review process should not be used to circumvent the comprehensive code for the assessment and collection of taxes set out in the Income Tax Act (ITA) and for which the Tax Court of Canada (TCC) is given exclusive jurisdiction.  As a general proposition, this is a correct approach to the taxation regime in Canada.  However, cases such as Chrysler Canada [2008 FC 727, aff’d 2008 FC 1049], JP Morgan Asset Management [2012 FC 651, aff’d 2012 FC 1366] and Canadian Pacific Railway [2012 FC 1030; aff’d 2013 FC 161] come to this Court and fall within this Court’s jurisdiction because of their unique factual circumstances.  This case, like those, revolves around a factual scenario which takes it out the pure assessment or appeal regime of the ITA and the jurisprudence recognizes that such matters can come within the jurisdiction of this Court.

Prothonotary Aalto explained his reasoning for allowing the applications to proceed:

[22]    In this case there are agreements which are alleged to have been entered into between Sifto and the Respondent which are alleged to have been breached.  These facts on their face do not engage issues of the correctness of assessments or appeals under the ITA.  They are therefore not bereft of any chance of success.  To the extent the breach of agreements and other allegations made in these applications engage matters beyond the scope of the correctness of an assessment or re-assessment they are not within the jurisdiction of the TCC.

[23]    The conduct of officials in CRA cannot be considered in determining the correctness of assessments [footnote omitted].  Such matters must be asserted in another Court.  Thus, the conduct of CRA officials as asserted by Sifto in this case relating to understandings and agreements cannot be considered by the TCC.

[24]    These applications engage more than a review of assessments to determine their correctness.  Therefore, it cannot be said that these applications are bereft of any chance of success.

In addition to arguing that the applications should be struck out in their entirety, the Crown argued in the alternative that certain allegations should be struck out or that the applications be stayed (by way of ”extension of time”) until the final determination of appeals against the assessments issued as a result of the impugned decisions.  Prothonotary Aalto had little difficulty dismissing each of the Crown’s alternative arguments.

The Crown has already made a motion asking a Federal Court judge to set aside the Prothonotary’s decision.  In light of the decisions of the Federal Court in Chrysler Canada, JP Morgan and Canadian Pacific, the Crown may very well be facing an uphill battle.

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Judicial review applications challenging Minister’s alleged violation of Voluntary Disclosure Policy and MAP agreement allowed to proceed: Sifto Canada Corp. v. MNR

We’ve gone global!

We’ve gone global . . . just like our clients. Today was our first day online at dentons.com giving you a “first look” at the impressive combination of SNR Denton, Salans and FMC to form Dentons. We now have more than 2,500 lawyers and professionals in 79 locations in 52 countries. What does this mean for our tax clients? We can help you access the right value-added tax expertise around the world, particularly when tax authorities in more than one jurisdiction are reviewing your affairs (e.g. simultaneous cross-border audits), when contentious issues arise with the Canada Revenue Agency or when you need to appeal to the Tax Court of Canada.

Questions? Just let us know.

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We’ve gone global!

CRA answers TEI’s questions about its new “risk-based audit process”

The Canada Revenue Agency has now published a set of answers to questions and concerns about the audit process presented to it by the Tax Executives Institute late last year (see our earlier blog post).

One of the highlights is the set of answers by the CRA to a series of questions about its new risk-based audit process.  The questions and answers on that subject are as follows:

Question 12 – Risk-based Audit Process

In 2011 CRA announced it was instituting a risk-based approach to audits whereby CRA would meet with senior representatives of the taxpayer to:

• Explain the redefined risk-based approach to large business compliance and how the approach affects taxpayers;

• Share CRA’s findings and observations noted during the taxpayer’s risk assessment; and

• Understand how the taxpayer manages tax risk at its highest governance levels.

With the first round of meetings with taxpayers complete, TEI has the following questions in respect of the approach:

a) Would CRA share its general observations, findings, trends, or conclusions with respect to the state of tax-risk governance?

Response by CRA:

The Approach to Large Business Compliance is being phased in over a five-year period commencing in 2010-11. During this period, CRA officials conduct meetings with Large Business enterprises’ senior executives to discuss tax compliance and risk of non-compliance associated with their business activities, governance regime, internal controls, and inherent and behavioral risk factors affecting their risk segmentation. At this point in time, it is still premature to draw general conclusions on the state of tax-risk governance. We have noted that there are taxpayers with no formal method of identifying and responding to corporate tax risk. These taxpayers are informed that this lack of tax risk governance, in the absence of other mitigating controls, will weigh negatively on their overall risk rating with the CRA.

b) In the interests of transparency, will CRA consider publishing a document outlining and discussing its review and risk-assessment process?

Response by CRA:

The CRA is of the view that the success of the Approach to Large Business Compliance is based on a well-informed, transparent tri-partite relationship. Providing further information on the risk assessment process in a published document would be in the best interests of all parties. As this initiative unfolds, the CRA will be in a better position to further communicate the risk-assessment process.

c) Has the first round of meetings with taxpayers led CRA to consider changes to its risk-assessment process and will it publicly announce the changes? Will affected taxpayers be apprised of changes to the scope of the risk-management approach that apply to their cases?

Response by CRA:

There have been no major changes in the risk assessment process. As expected, we are fine-tuning our risk assessment process and exploring ways to leverage technology in our drive to a more automated state and enhanced accuracy and efficiency.

d) Will CRA review the risk assessment with the affected taxpayer, including discussing the criteria and factors used to determine a taxpayer’s risk rating? If a taxpayer disagrees with its risk-assessment rating, what steps can it take to address its concerns?

Response by CRA:

During the face-to-face meetings, the taxpayer is informed of their risk rating. At that time, they will be informed of why they have attained this rating and what can be done to reduce the rating in the future. It is, however, not a debating forum where taxpayers can “negotiate” a better rating.

e) Assuming a taxpayer’s risk profile can change over time, will CRA revisit its risk-assessment ratings on a regular basis? If so, how often will the assessment be revised? Will CRA meet again with the taxpayer’s senior executives to review the revised rating?

Response by CRA:

Each taxpayer is risk assessed on a yearly basis based on the latest available information. Currently, as for the meetings, CRA officials are meeting with each Large Business taxpayer and discussing their individual risk rating over the 5-year phase-in period. Once this round of meetings is completed, CRA will consider revisiting taxpayers to review their rating.

f) Can CRA provide any details about the factors affecting a taxpayer’s risk rating?

Response by CRA:

The CRA’s Approach to Large Business Compliance (ALBC) discloses the criteria used in risk evaluating all taxpayers. The large business population is being risk assessed using several techniques, such as:

• Undertaking a historical analysis of audit results and a corresponding analysis of behavioural patterns;

• Examining every large business taxpayer in their TSOs and assessing their risk based on analysis and local knowledge;

• Conducting issue-based risk assessment to determine whether taxpayers are participating in tax planning schemes;

Additionally, consideration is being given to a number of risk factors, such as:

• Audit history;

• Industry sector issues;

• Unusual and/or complex transactions;

• Corporate structure;

• Major acquisitions and disposals;

• International transactions;

• Corporate governance;

• Participation in aggressive tax planning; and

• Openness and transparency.

These factors will vary by taxpayer and the taxpayers will be advised as to the factors considered in their risk assessment when the ALBC approach is discussed, in the face to face meeting that the CRA will hold with them. All factors are considered collectively in arriving a global risk rating for the entity.

g) Will CRA inform other tax jurisdictions (provincial or foreign) of its findings in respect of a taxpayer’s risk rating?

Response by CRA:

CRA has not shared any information related to any taxpayer’s risk rating with any other tax jurisdiction. In the future, any request made by another tax jurisdiction will be reviewed by the CRA on a case by case basis, while respecting the Provision of Information laws outlined in section 241 of the Income Tax Act and the relevant international exchange of information protocols.

h) What guidance has been provided to the TSOs to ensure that the objectives of the new audit approach are applied consistently by all the TSOs?

Response by CRA:

Given the prominence of risk assessment and the impact of risk rating on the design and implementation of the Approach to Large Business Compliance, a national risk assessment calibration committee has been formed to supplement the regional calibration committees thus ensuring national and regional consistency.

In certain other responses, the CRA refers to its strategic plan entitled “Vision 2020″ (question 2) and issues around Scientific Research & Experimental Development (question 3).  Both subjects will be discussed in detail at a breakfast seminar of the Toronto Centre CRA & Professionals Group at the Toronto Board of Trade to be held on Wednesday, February 6, 2013.

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CRA answers TEI’s questions about its new “risk-based audit process”

Tax Executives Institute raises important audit process questions and concerns in its annual meeting with the Canada Revenue Agency

Earlier this month, the Tax Executives Institute, Inc. (TEI) raised a number of important income tax administration issues in its annual meeting with the Canada Revenue Agency. Concerns were expressed about how the CRA conducts and manages large file audits (including the role of the Large File Case Manager or LFCM) as well as the design and development of the CRA’s new risk-based audit process for large businesses.

The agenda for those meetings (which also included the Department of Finance) is here.  TEI plans to publish CRA’s responses as soon as they are released.  The questions and concerns dealing with the audit process in particular are set out below.

7. CRA Audit Practices — Taxpayer Field Experience

CRA and large taxpayers share a common interest and goals in promoting a smooth and efficient audit. The goals include:

• Ensuring that audits are current;

• Avoiding the use of waivers to extend the audit period unnecessarily or habitually;

• Focusing audit queries on high-risk compliance issues;

• Using accepted audit sampling procedures to expand stretched resources;

• Maintaining transparency in decision-making and the determination of tax positions;

• Promoting timely, consistent, and effective issue resolution;

• Deploying human resources as effectively as possible; and

• Maximizing cost controls.

Over the course of the last several years, CRA has developed new audit approaches based upon an enhanced relationship with large taxpayers and a risk-based audit approach. TEI supports CRA’s new audit approach not only because of the common interest and shared goal of promoting efficiency, but because it promotes certainty of tax treatment sooner. That said, many large taxpayers have experienced behaviours seemingly at odds with the shared interests and goals. Examples include:

a) LFCMs are declining to discuss issues (or assert control over certain issues), saying they lack authority to make a decision in respect of subject matter. This suggests that issue resolution may be increasingly managed by CRA Headquarters in Ottawa as opposed to the TSOs. TEI believes that the objectives identified above can be advanced only if the LFCM is empowered to make decisions on issues and taxpayers are able to communicate directly with the decision-makers.

b) Auditors are asking for information on behalf of an undisclosed CRA source or seeking opinions or advice from CRA Headquarters without communicating the issue to the taxpayer or informing the taxpayer of the request. Where an opinion or advice is solicited, the TSO is generally bound by the Headquarters decision even though the taxpayer had little or no input into the development of the facts upon which the opinion is based.

c) Many auditors and LFCMs assert that they have no jurisdiction over specialty areas (e.g., SR&ED, International or Tax Avoidance matters). Thus, there seems to be no overriding coordinator or decision-maker.

d) The scope and nature of the tax treatment of items seem to change dramatically from previous years (i.e., fewer adjustments are proposed, but high-level conceptual challenges to a taxpayer’s filing position are asserted with minimal or no apparent technical analysis). Examples include challenges to reclassify amounts long treated (and frequently reviewed) as current expenses into capital items or challenges to the longstanding (and frequently reviewed) classification of capital items into longer-lived capital asset pools.

e) Adjustments are proposed without discussion or explanation of the technical position despite requests for the rationale, which leaves taxpayers questioning the quality of the audit or propriety of the asserted position. Without discussion, the position can seem arbitrary, and may be a consequence of the Tax Earned by Auditor (TEBA) metric.

f) Information requests or proposals for adjustments are submitted shortly before a taxation year becomes statute barred.

g) Certain audit queries seem intended to audit the taxpayer’s financial statements rather than the tax returns (e.g., there are instances where an auditor is verifying account balances in audited financial statements rather than trying to understand the adjustments on the tax returns to the financial accounts and the rationale for the adjustments).

h) Requests are made for significant amounts of data as opposed to relying on sampling where practical (e.g., requests for all professional fee invoices). In addition, information requests require taxpayers to produce enormous amounts of data within an abbreviated time frame. Response times should be reasonable and proportional to the volume of information requested.

i) Some auditors have refused to make taxpayer-favourable consequential changes and adjustments in subsequent years, even where the changes flow directly from an accepted audit adjustment to an earlier period. Instead, taxpayers are compelled to file amended returns to claim the consequential adjustments.

In addition to a general discussion of the member perceptions of audit behaviours and whether those behaviours are counterproductive to the shared goals of expeditious audits, transparency, and an enhanced relationship, TEI invites a discussion of the following:

a) In connection with the new risk-based audit approach, have quality control reviews been performed on the audit files since the approach was adopted? If not, will the quality control review be conducted on all files or all files above a certain size? Will new roles be created within CRA to conduct the quality control reviews independently of the field auditors?

b) Can CRA confirm whether the TEBA metric has been eliminated, as announced at the May 2012 TEI Annual Conference? If so, what measures will the Agency employ internally and for reporting its activities to other parts of the Government (e.g., Finance, Parliament, and the Auditor General)?

c) What other changes are being implemented at Headquarters and the TSOs to support the risk-based audit initiative?

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12. Risk-based Audit Process

In 2011 CRA announced it was instituting a risk-based approach to audits whereby CRA would meet with senior representatives of the taxpayer to:

• Explain the redefined risk-based approach to large business compliance and how the approach affects taxpayers;

• Share CRA’s findings and observations noted during the taxpayer’s risk assessment; and

• Understand how the taxpayer manages tax risk at its highest governance levels.

With the first round of meetings with taxpayers complete, TEI has the following questions in respect of the approach:

a) Would CRA share its general observations, findings, trends, or conclusions with respect to the state of tax-risk governance?

b) In the interests of transparency, will CRA consider publishing a document outlining and discussing its review and risk-assessment process?

c) Has the first round of meetings with taxpayers led CRA to consider changes to its risk-assessment process and will it publicly announce the changes? Will affected taxpayers be apprised of changes to the scope of the risk-management approach that apply to their cases?

d) Will CRA review the risk assessment with the affected taxpayer, including discussing the criteria and factors used to determine a taxpayer’s risk rating? If a taxpayer disagrees with its risk-assessment rating, what steps can it take to address its concerns?

e) Assuming a taxpayer’s risk profile can change over time, will CRA revisit its risk-assessment ratings on a regular basis? If so, how often will the assessment be revised? Will CRA meet again with the taxpayer’s senior executives to review the revised rating?

f) Can CRA provide any details about the factors affecting a taxpayer’s risk rating?

g) Will CRA inform other tax jurisdictions (provincial or foreign) of its findings in respect of a taxpayer’s risk rating?

h) What guidance has been provided to the TSOs to ensure that the objectives of the new audit approach are applied consistently by all the TSOs?

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Tax Executives Institute raises important audit process questions and concerns in its annual meeting with the Canada Revenue Agency

Tax Court of Canada upholds general policy that settlement agreements should be respected – taxpayer’s waiver of right to appeal was effective

In Noran West Developments Ltd. v. The Queen, the Tax Court of Canada (Justice Brent Paris) upheld the validity of a taxpayer’s waiver of its right to appeal executed following the conclusion of a settlement with the Appeals Division of the Canada Revenue Agency (the “CRA”).  This conclusion was reached, and the Crown’s motion to quash granted, notwithstanding the taxpayer’s valiant attempts to set aside the agreement.

The relevant statutory provision in subsection 169(2.2) of the Income Tax Act:

Waived issues

(2.2) Notwithstanding subsections 169(1) and 169(2), for greater certainty a taxpayer may not appeal to the Tax Court of Canada to have an assessment under this Part vacated or varied in respect of an issue for which the right of objection or appeal has been waived in writing by the taxpayer.

By way of background, the CRA audited a corporate taxpayer (the Appellant) in respect of unreported income from a condominium joint venture which engaged in certain non-arm’s length dispositions.  The auditor reassessed to (a) include $640,000 in the taxpayer’s income for its 2005 taxation year (on the basis of a valuation of the relevant condominium units), (b) recognize a shareholder benefit to the taxpayer’s sole shareholder and (c) apply gross negligence penalties under subsection 163(2) of the Income Tax Act in respect of both reassessments.

The taxpayer filed a notice of objection objecting to the inclusion of the $640,000 in its income (on the basis that the CRA’s valuation was wrong) and the assessment of a subsection 163(2) penalty.  The taxpayer’s sole shareholder filed no objection against his own reassessment.

Following discussions with the taxpayer’s representative, the Appeals Officer offered to settle the matter by (a) reducing the income inclusion by $50,000 (on the basis of a reduced valuation of the relevant condominium units) and (b) reducing the amount of the subsection 163(2) penalty accordingly.  The Appeals Officer sent a standard waiver letter which was signed by the taxpayer’s sole shareholder on behalf of the taxpayer.  It included the usual language in which the signatory attests that he or she is ”familiar with subsection 165(1.2) and 169(2.2) of the Income Tax Act and understand that I will be precluded from filing an objection or an appeal with respect to those issues.”

The CRA reassessed to implement the settlement, but the taxpayer filed an appeal in Tax Court in response.  The Crown moved to quash the appeal on the basis that the taxpayer had waived its right to appeal under subsection 169(2.2) of the Income Tax Act.  In answer to the motion counsel for the taxpayer advanced six arguments, none of which were successful:

1. The waiver agreement was not “in writing” as required by subsection 169(2.2) as the Appeals Officer omitted the taxpayer’s name.

The Tax Court judge concluded that “waived in writing” simply “requires that a waiver be reduced to writing as opposed to one given orally” and proceeded to find that the waiver agreement could not reasonably be read as applying to anyone other than the taxpayer.

2. The waiver agreement is unenforceable as the reassessment contemplated by that agreement would not have been consistent with the facts and the law.

The Tax Court judge found that there were errors in the first reassessment (the one that was settled).  However, the reassessment before the Court was the second reassessment (the one issued as a result of the waiver agreement).  As the second reassessment simply reduced the taxpayer’s income by $50,000 and reduced the subsection 163(2) penalty accordingly, there was no question that such a reassessment is within the CRA’s power.

3. The waiver agreement is invalid because the parties were not ad idem as to the terms of the agreement.  

First, it was said that the taxpayer’s sole shareholder believed that the waiver agreement applied to three taxpayers, not just one.  Therefore, there was no “meeting of the minds”.  Unfortunately for the taxpayer, the judge found that that belief, on the evidence, was “highly unlikely”.  In addition, an adverse inference was drawn from the failure of the taxpayer’s representative to give any evidence at all about what happened at the appeals stage.  The judge also rejected the contention that the sole shareholder believed that issue of beneficial ownership of the condominium units wasn’t covered by the waiver agreement and, therefore, there was no consensus ad idem.  There was no ”beneficial ownership” issue raised in the Notice of Objection, so there could be no reasonable expectation that it would have been reflected in the agreement.  The taxpayer’s final contention was that the sole shareholder did not believe that the waiver agreement dealt with the subsection 163(2) penalty.  As the text of the agreement dealt with the penalty, Justice Paris concluded that:

[61] . . . [i]f a party chooses not to read an agreement with care before signing it, or chooses to skip reading parts of it, I fail to see how he can turn around and allege that his intention did not accord with the written agreement. It must be presumed that, in those circumstances, the party intended to accept the agreement as written.

4. The agreement was vitiated by the CRA as it did not satisfy the terms of the waiver agreement because the subsection 163(2) penalty was incorrectly calculated on the second reassessment. 

Here is the error:

[24]  The respondent’s counsel concedes that an error was made in calculating the amount of the gross negligence penalty in the [second] reassessment and that the penalty was based on unreported income in the amount of $599,760 rather than on $589,760, as agreed. The respondent concedes that the penalty was too high by as much as $1,106. Because this error was only raised by Noran’s counsel shortly before the hearing of the motion, counsel for the respondent advised the Court that she was unable to obtain the exact amount of the error.

The Tax Court judge found himself unable to agree with the proposition that:

[65] . . . any inconsistency between the reassessment and the waiver agreement allows a taxpayer to appeal any aspect of the reassessment as if no waiver had been given.  It does not make sense that any error in reassessing, however minor, could permit a taxpayer to repudiate the waiver entirely.

5. The Tax Court should decline to enforce the waiver agreement on the basis that it is unconscionable. 

This argument was not pressed strongly.  In any event, the judge could find no evidence to support it.

6. The taxpayer is appealing issues other than those dealt with in the waiver agreement. 

This argument was based on the sole shareholder’s belief about what was covered by the agreement (which was rather narrow) rather than the text of the agreement itself.  Justice Paris rejected reliance on subjective belief and concluded that a “reasonable person” standard must be applied:

[74]  When searching for the intentions of the parties, I believe that the search for intention in the case of a waiver is to be conducted in the same manner as for any contract on the basis of the parties’ manifested intention. That intention is determined from the perspective of the objective reasonable bystander. Fridman in the Law of Contract in Canada, refers to the classical formulation of this notion in Smith v. Hughes:

If whatever a man’s real intention may be, he so conducts himself that a reasonable man would believe that he was assenting to the terms proposed by the other party and that other party upon that belief enters into a contract with him, the man thus conducting himself would be equally bound as if he had intended to agree to the other party’s terms.

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Underlying this decision is a clear public policy that negotiated settlements, as a general matter, ought to be upheld:

[45] . . . The desirability of upholding negotiated settlements was discussed by Bowie J. in 1390758 Ontario Corp v. The Queen:

[35] I agree with Bowman C.J. and the authors Hogg, Magee and Li that there are sound policy reasons to uphold negotiated settlements of tax disputes freely arrived at between taxpayers and the Minister’s representatives. The addition of subsection 169(3) to the Act in 1994 is recognition by Parliament of that. It is not for the Courts to purport to review the propriety of such settlements. That task properly belongs to the Auditor General.

[36] The reality is that tax disputes are settled every day in this country. If they were not, and every difference had to be litigated to judgment, unmanageable backlogs would quickly accumulate and the system would break down.

[37] The Crown settles tort and contract claims brought by and against it on a regular basis. There is no reason why it should not settle tax disputes as well. Both sides of a dispute are entitled to know that if they invest the time and effort required to negotiate a settlement, then their agreement will bind both parties.

Although the taxpayer was unsuccessful, this decision is ultimately reassuring as the same principle applies to the government - if the CRA attempts to resile from a settlement agreement it too will be confronted by the same underlying public policy, namely, that negotiated settlements of tax disputes should be respected.

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Tax Court of Canada upholds general policy that settlement agreements should be respected – taxpayer’s waiver of right to appeal was effective

Extensive Amendments to Tax Court of Canada Rules (General Procedure) Published in Part I of the Canada Gazette

General Objectives of the Proposed Amendments

The general objectives of the proposed amendments are:

(1) to streamline the process of hearings and to codify the practice relating to litigation process conferences;

(2) to implement new rules and amend existing rules governing expert witnesses and the admissibility of their evidence in the Tax Court of Canada;

(3) to allow the Court to proceed with a hearing of one or more appeals, while other related appeals are stayed pending a decision on the lead cases heard by the Court;

(4) to encourage parties to settle their dispute early in the litigation process; and

(5) to make technical amendments.

Detailed Description of Proposed Amendments

(1) Streamlining the process of hearings and codifying the practice relating to litigation process conferences

A proposed definition of “litigation process conference” is added to section 2. That definition lists the hearings referred to in section 125 and the conferences referred to in subsection 126(2) and sections 126.1 and 126.2.

Amendments are proposed to subsection 123(4) to indicate that the Registrar or a designated person may fix the time and place for the hearing subject to any direction by the Court.

Proposed subsection 123(4.1) indicates that the Court may, on its own initiative, fix the time and place for the hearing.

Proposed subsection 123(6) indicates that, if the time and place for a hearing have been fixed after a joint application of the parties, the hearing should not be adjourned unless special circumstances justify the adjournment and it is in the interest of justice to adjourn it.

Amendments are required to be made to section 125 (Status Hearing) to provide that initial status hearings are ordered to take place approximately two months after the filing of the reply, and further status hearings can take place later in the appeal to ensure the appeal is ready for trial and to fix a trial date. Finally, proposed subsection 125(8) provides that where a party fails to comply with an order or direction made at a status hearing, or if a party fails to appear at a status hearing, the Court may allow or dismiss the appeal or make any other order that is appropriate.

Existing section 126 is replaced by proposed section 126, which is designed to allow the Chief Justice to assign a judge to manage an appeal that is complex, or slow moving, or for some other reason requires ongoing management by a judge. The judge takes responsibility for the progress of the appeal to ensure that the appeal proceeds to trial in a timely way while conserving judicial resources.

Proposed section 126.1 provides that a trial management conference can be held after the appeal hearing date has been set and is presided over by the judge assigned to preside at the hearing. The conference is to ensure that the hearing proceeds in an orderly and organized fashion.

Proposed section 126.2 permits the Court to direct that a conference be held for the purpose of exploring the possibility of settlement of any or all of the issues.

Amendments are required to section 127 to add references to sections 125 and 126, and to proposed section 126.1.

Amendments are required to section 128 to add references to matters related to a settlement or settlement discussions during a litigation process conference.

(2) Implementing new rules and amending existing rules governing expert witnesses and the admissibility of their evidence in the Tax Court of Canada

Subsection 145(1) is amended to replace the reference to “affidavit” by “expert report.”

Proposed subsection 145(2) provides that the expert’s report must set out the proposed evidence of the expert, the expert’s qualifications and be accompanied by a certificate signed by the expert acknowledging that the expert agrees to be bound by the Code of Conduct for Expert Witnesses that is added as a schedule to the Rules to ensure that expert witnesses understand their independent advisory role to the Court. Proposed subsection 145(3) indicates that if an expert fails to comply with the Code of Conduct, the Court may exclude some or all of the expert’s report.

Proposed subsection 145(4) requires a party to seek leave to the Court if they intend to call more than five expert witnesses at a hearing and proposed subsection 145(5) indicates what the Court has to consider in deciding to grant leave.

Proposed subsection 145(6) allows parties to name a joint expert witness.

Existing subsection 145(2) is renumbered subsection 145(7) and specifies the conditions that need to be met in order for evidence of an expert witness to be received at the hearing.

Existing subsection 145(4) is renumbered subsection 145(8) and indicates how evidence in chief of an expert witness is to be given at a hearing.

Proposed subsection 145(9) indicates what may be addressed during a litigation process conference, other than a settlement conference, in respect of expert witnesses.

Proposed subsections 145(10), (11), (12), (13) and (14) introduce new rules that deal with expert conferences.

Existing subsection 145(3) is renumbered subsection 145(15) and is amended to change the number of days, from 15 to 60, for a copy of rebuttal evidence to be served on all parties.

Proposed subsection 145(16) indicates when evidence of an expert witness can be led in surrebuttal of any evidence tendered under subsection (15).

Proposed subsections 145(17), (18), (19) and (20) allow the Court to require that some or all of the experts testify as a panel. Experts are only allowed to pose questions to each other with leave of the Court to ensure the orderly presentation of evidence. The rules governing cross-examination and re-examination will continue to apply to experts testifying concurrently.

(3) Allowing the Court to proceed with a hearing of one or more appeals, while other related appeals are stayed pending a decision on the lead cases heard by the Court

Proposed section 146.1 is intended to apply where there is more than one appeal which has common or related issues of fact or law. It allows the Court to proceed with the hearing of one of the appeals, the lead case, while other related appeals are stayed pending a decision on the lead case. The parties in a related appeal have to agree to be bound, in whole or in part, by the final decision on the lead case.

(4) Encouraging parties to settle their dispute early in the litigation process

The provisions of the Rules addressing offers to settle are designed to encourage parties to settle their dispute early in the litigation process. An early settlement has the added advantage of reducing the costs borne by the parties and conserving judicial resources.

Parties are entitled to make and accept offers of settlement at any time before there is a judgment and any written offer to settle will be considered by the Court in assessing costs under section 147. In addition to this general rule, there is a need to encourage parties to reach an early settlement, ideally before the beginning of the trial or hearing. This is the specific objective of adding subsections 147(3.1) to (3.8).

(5) Making technical amendments

To amend section 6 to provide that the Court may direct that any step in a proceeding may be conducted by teleconference, by videoconference or by a combination of teleconference and videoconference.

To amend section 52 by adding a new subsection to provide that a demand for particulars shall be in Form 52 and shall be filed and served in accordance with the Rules, and to add Form 52 to Schedule I.

To amend sections 53 and 58 to regroup all matters where the Court may strike out or expunge all or part of a pleading or other document under section 53, and all matters relating to the determination of questions of law, fact or mixed law and fact under section 58. As a consequence of these changes, sections 59, 60, 61 and 62 are repealed.

To add subsection 67(7) to provide for when proof of service of a motion must be filed.

To repeal subsection 95(3) as a result of the changes made to the expert witness rules.

To amend subsection 119(3) as a result of the changes made to the expert witness rules.

To amend paragraph 146(1)(d) to change the number of days for service from 10 to 5.

To add subsection 153(3) to provide that the taxing officer may direct that the taxation of a bill of costs be conducted by teleconference, videoconference or by combination of both.

To amend the reference to “issuing a judgment” by “rendering a judgment” in subsection 167(1).

To remove the reference to “and it shall be entered and filed there whereupon section 17.4 of the Act shall be complied with” in subsection 167(3).

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The full text of the proposed amendments is here. Interested persons may make representations concerning the proposed Rules within 60 days after December 8, 2012. All such representations must cite the Canada Gazette, Part Ⅰ, and the December 8th date of publication of the notice, and be addressed to the Rules Committee, Tax Court of Canada, 200 Kent Street, Ottawa, Ontario K1A 0M1.

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Extensive Amendments to Tax Court of Canada Rules (General Procedure) Published in Part I of the Canada Gazette