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Crown bound by settlement agreement to allow losses it claimed to be a fiction

In the recent decision Her Majesty the Queen v. CBS Canada Holdings Co., 2020 FCA 4, the Federal Court of Appeal held that the Crown (i.e., Her Majesty the Queen, representing the Minister of National Revenue and her agent the Canada Revenue Agency) could not resile from a settlement agreement with a taxpayer into which it had entered freely, simply because the Crown’s assumptions on which it had decided to enter into the agreement turned out to be wrong (or at least may have been wrong).

The taxpayer had claimed a non-capital loss-carry-forward, which the Minister denied by way of an assessment. The taxpayer appealed the assessment to the Tax Court of Canada. Before trial, the parties reached an out-of-court settlement under which the Crown agreed to allow the loss carry-forward.

After signing the agreement, the Crown refused to implement it on then basis that it was “factually indefensible with no bearing in reality, therefore, illegal and non-binding on the Minister”. In short, the Crown now took the position that there were no losses and hence the agreement agreeing to allow such losses to be carried forward could not be enforced. The Crown relied on an old case called Galway for the principle that the Tax Court will not implement a settlement agreement or Consent Judgement unless it reflects a “principled” approach to the appeal, that is, unless it reflects terms that the Court itself might have granted in a Judgment had the matter gone to trial (one wonders what led the Crown to agree to the agreement in the first place, but that is irrelevant for present purposes).

The taxpayer applied to the Tax Court for an order requiring the CRA to reassess in accordance with the agreement. The Tax Court held and the Federal Court of the Appeal agreed, that the Crown could not resile from the agreement; the Crown entered into the agreement freely and believed the agreement to be in accordance with the facts and the law at the time it did so. The Courts held that the general principle is that parties, including the Crown, should be bound by agreements into which they enter. As for Galway, the FCA held that it was still good law but did not apply on these facts, primarily because it was not self-evident that the settlement agreement was wrong or invalid or contained terms that the Tax Court could not have found had the matter gone to trial. As the FCA said: “Galway intended that courts would intervene only in very limited circumstances where it was evident on the face of the limited material before the Court there was a factual or legal problem with the settlement.”

The Courts’ decisions provide surety to a taxpayer who enter into a settlement agreement with the Crown, as the Crown will not be able refuse to implement it if it later learns or believes that the factual basis of the settlement was incorrect.

The Crown argued also that it could not reassess the taxpayer in accordance with the settlement agreement because that would result in the taxpayer owing an increased amount of tax in one of the years in issue. However, the FCA held that this was irrelevant: it was the taxpayer, not the CRA, that was seeking an order that would result in an increase in taxes payable. This did not violate the rule that the CRA cannot appeal its own assessment so as to increase the tax assessed.

Crown bound by settlement agreement to allow losses it claimed to be a fiction

Scope of Canada Revenue Agency Audit Powers Limited by Recent FCA Decision. The CRA Response Raises New & Different Risks for Taxpayers

The Federal Court of Appeal recently drew clear boundaries around the CRA’s audit powers, holding that the Agency cannot compel employees of a taxpayer to attend interviews to answer oral questions as part of an audit. In Canada v. Cameco Corporation, 2019 FCA 67, the CRA sought a compliance order under subsection 231.7(1) of the Income Tax Act to required employees of Cameco to attend oral interviews. Cameco refused, but was willing to answer questions in writing, in response to requests to named employees.

There is no argument about the CRA power to “inspect, audit or examine” the books and records of a taxpayer (paragraph 231.1(1)(a), Income Tax Act). The CRA argued that this provision grants the Agency the power during an audit to require taxpayers, or employees of taxpayers, to be interviewed orally.  This presumably would also mean that those individuals would be forced to answer the questions put to them at these interviews or risk being in breach of their obligations under the Act. Fortunately for all taxpayers, both the Federal Court and the Federal Court of Appeal rejected the CRA’s attempt on summary application to compel the employees of Cameco to attend oral interviews. In a recently released statement regarding the Cameco decision, the CRA confirmed that it will not seek leave to appeal the decision to the Supreme Court of Canada. As a result, this decision is binding on the CRA and will remain as the current state of the law, barring any future legislative changes expanding the scope of the CRA’s audit powers.

However, the CRA is not finished. The CRA went on to state that it would continue to seek oral interviews of “taxpayers, their employees, representatives, related parties and any other person it deems necessary in carrying out its audit functions”.  Further, if the taxpayer rejects such attempts, or if the CRA feels that a taxpayer is not providing adequate information, then it will likely assess the taxpayer based on assumptions that may be incorrect.  This is an astonishing threat that all taxpayers facing an audit should be aware of.  It is essential for taxpayers and their representatives to understand the scope of CRA’s audit powers in determining how to provide information to the CRA. It is also important to have a clear audit plan and an assessment of risk when dealing with inquiries from the CRA.

Communications between accountants and their clients facing these sorts of audits are not covered by solicitor-client privilege, and in any event, these are critical issues of taxpayer rights and Constitutional proscriptions of government audit power.  When facing these sorts of issues, it is important to be proactive and not just react to the CRA positions in the audit.  Taxpayers should retain the services of lawyer when facing demands and threats from the CRA.

Dentons Canada LLP has lawyers with extensive experience in tax dispute resolution who can assist taxpayers at the audit, objections, and court appeals level. If you need assistance with a tax dispute, you can contact Gergely Hegedus at 780-423-7282 or email at gergely.hegedus@dentons.com

Scope of Canada Revenue Agency Audit Powers Limited by Recent FCA Decision. The CRA Response Raises New & Different Risks for Taxpayers