A tax dispute with the Canada Revenue Agency may be an unwelcome and unpleasant experience for a taxpayer. In addition to the potentially complex tax issues, the dispute resolution process itself can be a nuanced and challenging process. However, an appeal to the Tax Court of Canada offers taxpayers a chance to have their disputes considered by “fresh eyes,” which could result in a victory, settlement or other efficient resolution.
Taxpayer wins an important and complex case – Tax Court orders CRA to pay 60% of his out-of-pocket costs
Traditionally in a Tax Court appeal the costs awarded to a successful taxpayer have been no more than a small fraction of the out-of-pocket costs actually incurred in pursuing the appeal. The Court made very rare exceptions in the case of improper or vexatious conduct on the part of CRA. In recent years, however, the Tax Court has shown an increasing willingness to award substantial costs in cases where the taxpayer has been successful on important and novel issues. The recent decision of the Tax Court in Dickie v. The Queen (September 19, 2012) is an important example of how the law is evolving in this area.
In order to understand the implications of the cost award one must briefly examine the background of the underlying tax issue which was reported as Dickie v The Queen (July 10, 2012). The taxpayer was an aboriginal person living on a Reserve. He carried on a substantial business of cutting and slashing timber and brush to permit oil and gas exploration companies to carry out seismic testing. The administrative functions of the business were carried on within the Reserve but the physical activity of the business was carried on almost exclusively outside of the Reserve, generally within an 80 kilometre radius of the Reserve:
 While the Appellant clearly negotiated and received accepted contracts for work from the Reserve location, it is clear that 99% of the work was conducted off Reserve, within an 80-kilometre radius of the Reserve. In 2003, the Appellant had over 140 workers engaged for his Business and had revenue of approximately $3.4 million. The Appellant testified he hired mainly aboriginal workers, 16 in all from the Reserve, and others from Reserves in other parts of British Columbia, Alberta, Saskatchewan and even as far away as Newfoundland and Labrador. In all, the evidence is that approximately 105 of the 140 workers were aboriginal workers.
 The Appellant testified that the Business would bid on between 20 to 25 tenders a year and was usually successful 20% of the time, hence was awarded four to five contract bids a year. He also testified a small portion of the work of the Business was from small job requests but that the great majority of the Appellant’s Business revenue was from the larger bid contracts. The evidence is clear that all of the clients of the Business, generally oil and gas exploration or distribution companies, were not located or based on the Reserve and in fact most were based in Calgary, Alberta, the place of their office. The Appellant also testified that in 2003 the Business was a competitive one, evidenced also by the fact he was only successful on 20% of his bids.
The taxpayer claimed that his income was exempt for taxation by virtue of paragraph 81(1)(a) of the Income Tax Act:
81(1) There shall not be included in computing the income of a taxpayer for a taxation year,
(a) statutory exemptions [including Indians] – an amount that is declared to be exempt from income tax by any other enactment of Parliament, other than an amount received or receivable by an individual that is exempt by virtue of a provision contained in a tax convention or agreement with another country that has the force of law in Canada; . . .
Traditionally the courts construed this exemption somewhat narrowly placing significant emphasis on physical connection to the reserve and displaying a certain reluctance to apply the exemption to activities in the commercial mainstream.
Two recent decisions of the Supreme Court of Canada, Bastien Estate v. Canada, 2011 SCC 38,  2 S.C.R. 710 and Dubé v. Canada, 2011 SCC 39,  2 S.C.R. 764, substantially changed the law in this area. In a nutshell they held that the commercial mainstream test should no longer carry the degree of weight it had historically:
 Cromwell J. made it clear that the expression “Indian qua Indian” referred to by La Forest J. and Gonthier J. in Williams does not mean one can import into the purpose of the legislation “an effort to preserve the traditional way of life in Indian communities” or consider as a relevant factor “whether the investment income benefits the traditional Native way of life”. While Cromwell J. found that he did not read the judgments in Mitchell or Williams “as departing from a focus on the location of the property in question when applying the tax exemption”, he also found that neither decision mandated an approach that assessed what is in fact, to use the parlance of the Appellant here, the “Indianness” of the activity. In paragraph 27 of Bastien Estate, Cromwell J. stated:
 . . . A purposive interpretation goes too far if it substitutes for the inquiry into the location of the property mandated by the statute an assessment of what does or does not constitute an “Indian” way of life on a reserve. . . .
 And in paragraph 28 stated:
 . . ., a purposive interpretation of the exemption does not require that the evolution of that way of life should be impeded. Rather, the comments in both Mitchell and Williams in relation to the protection of property which Indians hold qua Indians should be read in relation to the need to establish a connection between the property and the reserve such that it may be said that the property is situated there for the purposes of the Indian Act. While the relationship between property and life on the reserve may in some cases be a factor tending to strengthen or weaken the connection between the property and the reserve, the availability of the exemption does not depend on whether the property is integral to the life of the reserve or to the preservation of the traditional Indian way of life. . .
 Likewise Cromwell J. cautioned against elevating considerations of whether the economic activity was in the “commercial mainstream” as a factor of determinative weight in determining the situs of investment income, which he felt was done in Recalma v. Canada, 98 DTC 6238 (F.C.A.) and other decisions of the lower courts, as “problematic” as he stated in paragraph 56 :
 . . . because it might be taken as setting up a false opposition between “commercial mainstream” activities and activities on a reserve. Linden J.A. in Folster was alive to this danger when he observed that the use of the term “commercial mainstream” might “… imply, incorrectly, that trade and commerce is somehow foreign to First Nations” (para. 14, note 27). He was also careful to observe in Recalma that the “commercial mainstream” consideration was not a separate test for the determination of the situs of investment property, but an “aid” to be taken into consideration in the analysis of the question (para. 9). Notwithstanding this wise counsel, the “commercial mainstream” consideration has sometimes become a determinative test. . . .
Justice Pizzitelli applied the new test enunciated by the Supreme Court and came to the conclusion that the taxpayer had demonstrated an entitlement to the exemption claimed and made the following direction as to costs:
 The appeal is allowed with costs to the Appellant; however, the parties are invited to file written submissions within 30 days as to costs if any of them feel a standard cost award should not stand.
In making his cost award roughly two months later Justice Pizzitelli was critical of CRA’s reliance upon the “commercial mainstream” argument in light of the Bastien and Dubé decisions:
 I do however also agree with the Appellant that having regard to the clear wording and intention of the Supreme Court of Canada’s decisions effectively reducing the importance of the commercial mainstream factor, if not obliterating it, that the Respondent could have shortened the proceeding by conceding this fact before trial. While the Respondent’s counsel acknowledged the reduction in weight to be given to the issue in argument at trial, she nonetheless maintained its assumptions in its pleadings regarding the commercial mainstream and argued forcefully that such factor would grant an advantage to aboriginal businesses over non-aboriginal businesses, an argument in my opinion clearly not consistent with the Supreme Court of Canada’s decisions on the issue. As I referred to in my decision, if the other factors are sufficient to establish the income was situate on a Reserve, then any such resulting advantage was acceptable. In my view, the Respondent could have significantly reduced the length of the hearing by conceding the argument before trial on receiving the Appellant’s counsel’s letter. In my view, this matter falls under the heading of Rule 147(h) the denial or the neglect or refusal of any party to admit anything that should have been admitted. In my opinion, the Respondent paid lip service to the Supreme Court of Canada’s decisions on the importance of the commercial mainstream argument yet proceeded to trial on the basis it was one of its strongest arguments.
In the result he awarded the taxpayer 60% of his out-of-pocket costs and 100% of his disbursements claimed:
 In my view, having regard to the clear victory of the Appellant in this matter, the sizeable amount of taxes in dispute including for other years for which this case served as a test case, the importance of the commercial mainstream issue in particular and the complexity of the issue in light of the Respondent’s position notwithstanding the Supreme Court of Canada’s decisions in Bastien Estate and Dubé and the amount of work generated for the Appellant as a result of the Respondent’s position on that issue and the importance it continued to give to the commercial mainstream factor as above discussed, which in my view should have been conceded before trial to shorten the trial and narrow the issues, there clearly exist special circumstances justified by the application of factors listed in Rule 147(3) to merit awarding the Appellant costs in excess of the Tariff.
 The Appellant asked for between 50 and 75% of solicitor and client costs plus disbursements, consistent with the range of traditional awards cited by author Mark Orkin in the Law of Costs, 2nd ed., Vol. 1 (Aurora: Canada Law Book, 2008) at 2-3 as quoted by Campbell J. in Re Zeller Estate above at paragraph 9. The Appellant’s costs on a solicitor and client basis claimed are $133,000 plus $10,000 in disbursements. In my opinion, the Appellant is deserving of 60% of such claim, amounting to $80,000 plus $10,000 in disbursements, for a total award of $90,000.
While the background of this case is somewhat uncommon, the issues it presents occur frequently in serious commercial tax litigation: important, novel issues involving a great deal of tax. When this is combined with a stubborn refusal on the part of CRA to acknowledge the obvious weaknesses of some of its arguments, we may begin to see more significant costs awards in the mold of the Dickie decision.
In Hine v. The Queen (2012 TCC 295), a decision released last week, the Tax Court of Canada considered whether a taxpayer was “grossly negligent” in relying on his accountant (who happened to be his wife) to prepare his tax return, and whether the taxpayer’s written offer to settle (asking the Crown to concede entirely) should be considered when making a cost award.
The decision in Hine is helpful in determining (a) whether the taxpayer was grossly negligent in relying entirely on his tax preparer, and (b) whether a settlement offer may be ignored by the Tax Court in awarding costs.
Gross Negligence – 163(2)
The taxpayer was a general contractor who was in the business of “flipping” homes. In 2006, he sold a renovated house for $319,000. The taxpayer reported a loss of $131,653 for the year. In the course of an audit that commenced in 2008, the CRA discovered that the taxpayer had failed to report $157,965 of business income on the sale of the house. The CRA reassessed to include the additional income and imposed a gross negligence penalty under subsection 163(2) of the Income Tax Act. Only the gross negligence penalty was at issue in the appeal.
Generally, under subsection 163(2), the CRA may impose a penalty equal to the greater of $100 and 50% of the avoided tax where the taxpayer knowingly, or under circumstances amounting to gross negligence, made a false statement or omission in a return.
The courts have been consistent in holding that a high degree of negligence or intentional acting is required in order for the gross negligence penalty to apply (see, for example, Udell v. M.N.R., 70 DTC 6019 (Ex. Ct.)). However, there has been less consistency in the application of the penalty where the taxpayer relied on the work of his/her tax preparer. Generally, in such cases, there must be gross negligence on the part of the tax preparer, and there must be some element of privity or wilful blindness on the part of the taxpayer such that he/she acquiesced in the making of the false statement or should have taken further steps to confirm the accuracy of the return.
In Hine, the taxpayer handed over responsibility for the bookkeeping and tax returns to his wife, who had a background in financial accounting but was not a professional accountant. The taxpayer relied entirely on his wife to keep proper records and prepare his returns. The wife’s error resulted in the underreported income, and neither the taxpayer nor his wife detected the error before filing the return.
In argument, the taxpayer relied on a line of cases establishing that reliance on professional advisors does not necessarily lead to a finding of gross negligence (see, for example, Findlay v. The Queen (2000 DTC 6345 (Fed. C.A.)), Gallery v. The Queen (2008 TCC 583) and Down v. M.N.R. (93 DTC 591) (T.C.C.)). The Crown relied on a line of cases that states that a taxpayer cannnot escape his or her own liability under subsection 163(2) by simply handing over all tax affairs to a professional advisor (see, for example, Panini v. The Queen (2006 FCA 224), Hougassian v. The Queen (2007 TCC 293) and Brygman v. M.N.R. (79 DTC 858) (Tax R.B.)).
The Tax Court found that the taxpayer and his wife intended to be diligent and accurate in reporting the taxpayer’s income, and an honest confusion led to the error.
Finally, the Tax Court held that the determination of the issue of whether the taxpayer and his advisor were grossly negligent was unaffected by the their spousal relationship. On the facts of the case, the taxpayer’s “blind faith in his wife” was not unreasonable. The Tax Court allowed the taxpayer’s appeal.
After the court’s decision, the taxpayer sought costs above the usual tariff amounts on the basis that a settlement offer had been made before the hearing. The taxpayer argued that the offer should be considered under paragraph 147(3)(d) of the Tax Court of Canada Rules (General Procedure) and enhanced costs awarded.
In his written offer, the taxpayer had set out certain submissions he intended to make at the hearing and argued that the gross negligence penalty was unsupportable. The taxpayer offered to settle the matter, without costs, if the Crown reassessed accordingly (i.e., conceding the penalty in its entirety). The taxpayer stated that if the Crown did not accept the settlement offer the taxpayer would seek solicitor and client costs if successful at trial. The Crown rejected the offer.
The Tax Court dismissed the taxpayer’s request for enhanced costs and stated that “… An ‘offer’ that the other party to the litigation withdraw in order to avoid a threat of enhanced costs cannot, in this circumstances, be considered to be an ‘offer of settlement’.” Further, the court stated that, “To have ‘settled’ the case as offered by the Appellant would have been to abdicate the responsibilities imposed on the Department of Justice.” (See also CIBC World Markets Inc. v. The Queen (2012 FCA 3) on the difficulties of making a settlement offer where there is a “yes-no” question at issue in the appeal.)
Accordingly, parties to a tax dispute should ensure that their offers are “settlement” offers and not “withdrawal” offers and that the offer is the type of offer that can indeed be accepted by the other party. Otherwise a court may decline to consider the offer when assessing costs.
In what circumstances can a party obtain a large lump-sum cost award after a favourable Tax Court decision?
That was the question considered by the Tax Court in Velcro Canada Inc. v. The Queen (2012 TCC 273), in which the Tax Court awarded the successful taxpayer a lump sum cost award of $60,000 plus disbursements. The Court’s reasoning has provided some helpful clarification on the manner in which the Court will determine the nature and amount of a cost award.
In the main appeal (Velcro Canada Inc. v. The Queen, 2012 TCC 57), the Appellant taxpayer was successful in establishing that a Dutch holding company was the “beneficial owner” of royalties paid by a related Canadian company. (See our previous commentary on the decision by FMC’s Matt Peters here.)
At the costs hearing, the Appellant argued that the Tax Court should award enhanced costs because the Appellant had been entirely successful in the appeal, the amount in issue was in excess of $9 million, the issues raised were of national and international importance, and the novelty of the issues required additional time and resources in preparing for and conducting the appeal.
The Respondent’s view was that costs should be assessed in accordance with Tariff B of Schedule II of the Tax Court of Canada Rules (General Procedure). The Respondent argued that the main issue had previously been considered in the ground-breaking case of Prévost Car Inc. v. The Queen (2008 TCC 231; aff’d 2009 FCA 57), and that the Appellant had not adduced evidence of the work and effort put into the appeal. Further, no exceptional circumstances existed that would justify the Court exercising its discretion to award costs beyond the Tariff.
The Tax Court considered the factors discussed in section 147 of the General Procedure Rules and Tariff B of Schedule II thereto, and concluded that no exceptional circumstances were required to justify a deviation from the Tariff. In fact, the discretion of the Tax Court is quite wide – the Tariff may be relied on, but only if the Court chooses to do so. The Court stated:
 Under the Rules, the Tax Court of Canada does not even have to make any reference to Schedule II, Tariff B in awarding costs. The Court may fix all or part of the costs, with or without reference to Schedule II of Tariff B and it can award a lump sum in lieu of or in addition to taxed costs. The Rules do not state or even suggest that the Court follow or make reference to the Tariff. …
 It is my view that in every case the Judge should consider costs in light of the factors in Rule 147(3) and only after he or she considers those factors on a principled basis should the Court look to Tariff B of Schedule II if the Court chooses to do so. … [emphasis in original]
The Court went on to consider the result in the proceeding (taxpayer was entirely successful), the amount in issue (more than $9 million), the importance of the issues (very important domestically and internationally), any settlement offer in writing (there wasn’t one), the volume of work (considerable effort required), the complexity of the issues (relatively straight-forward but in a complex factual matrix), and the conduct of the parties (very well pleaded and impressive presentations at the hearing). The Court awarded $60,000 plus disbursements to the Appellant.
The Court’s decision is significant because it signals an evolution in the approach to cost awards from the currently accepted practice.
As most tax litigators know, a general practice developed whereby large lump-sum cost awards were sought only in exceptional circumstances (i.e., where one party had engaged in misconduct or unnecessary procedural wrangling). The decision of Associate Chief Justice Rossiter appears to open the door to the possibility of seeking large lump-sum cost awards in any proceeding because, according to the Court, the Judge should look first to section 147 of the Rules and may, but not necessarily, look to the Tariff.
It seems that this approach accords with the Tax Court’s recent focus, and emphasis, on the importance of settlements. The parties to a tax appeal should not lightly dismiss the Court’s reasoning in Velcro Canada when considering whether to settle a matter before going to trial.
On January 10, 2012, the Federal Court of Appeal (the “FCA”) released its decision in CIBC World Markets Inc. v. The Queen (2012 FCA 3) on a motion by the taxpayer seeking an order for enhanced costs. In a unanimous judgment, Justices Sharlow, Layden-Stevenson, and Stratas dismissed the taxpayer’s motion, holding that there was no legal basis upon which the Minister of National Revenue could have accepted the offer of the taxpayer to settle the claim.
The underlying litigation dealt with a claim for input tax credits (“ITC”s) under the Excise Tax Act. Specifically, the issue was whether the taxpayer was entitled to file a second claim for input tax credits in respect of the same year (further details are available in our earlier posts on the litigation). Litigation commenced, with the result that the taxpayer was unsuccessful at the Tax Court of Canada (2010 TCC 460) but was successful at the Federal Court of Appeal (2011 FCA 270).
At issue on the motion before the FCA was an offer of settlement made by the taxpayer before the commencement of proceedings at the Tax Court of Canada. The offer put forward by the taxpayer would have had the Minister issue a reassessment granting 90% of the ITCs at issue. It had no expiry date and was left open for acceptance throughout the remainder of the action. In its motion, the taxpayer argued that because it was entirely successful at the FCA, it should be entitled to 80% of solicitor and client costs, beginning from the date of offer and ending on the judgment by the FCA (80% being the “substantial indemnity” set out in Practice Note No. 18 of the Tax Court of Canada).
The FCA first dispensed with the taxpayer’s claim for enhanced costs in respect of the FCA action, noting that an offer of settlement made before trial must be reasserted after the trial decision if the offeror intends it to be effective in respect of the FCA proceeding as well. As the taxpayer did not do so in this case, the only matter at issue were costs between the time of offer and the judgment of the Tax Court of Canada.
In dealing with that portion of the motion, the FCA noted that the rules governing offers of settlement include an implicit and important pre-condition that the offer made must actually have been capable of acceptance to trigger cost consequences. In this case, the Minister asserted that the offer to settle (by permitting 90% of the ITCs initially claimed) was an arbitrary compromise on quantum, and was not legally supportable under the legislation – neither the Tax Court of Canada nor the FCA could have ordered such a result. This kind of issue was described by the Minister as a “yes-no” issue of statutory interpretation where the taxpayer’s position was either entirely correct, or would be wholly rejected.
The FCA agreed with the Minister, relying on Galway v. Minister of National Revenue,  1 FC 600 and subsequent decisions under the Income Tax Act. Those decisions reflect the requirement that all settlements must be made on a “principled basis”: the Minister can only accept a settlement that is consistent with the legislation and the result that the legislation would allow. Compromise decisions and risk mitigation are impermissible if not otherwise supported by the legislation. The FCA confirmed that this rule applies equally to the Excise Tax Act, and that “there is no legislative provision that repeals Galway”.
The taxpayer argued that compromise settlements would help to relieve the backlog of appeals at the Tax Court of Canada and should therefore be permitted as good policy. The Court was not persuaded by this argument, suggesting that there are many policy considerations, in favour and against compromise settlements, and that it was a matter for Parliament, not the judiciary, to decide.
This decision affirms that Galway remains the governing law with respect to settlements, and that a “principled basis” remains a requirement for all settlements, unless Parliament takes action to change the present state of the law. Suggestion have been offered by commentators as to what such legislative reform might look like. For one analysis, based on a multi-jurisdictional perspective, see Carman R. McNary, Paul Lynch, and Anne-Marie Lévesque, “Tax Dispute Resolution: Is there a Better Way?,” Report of Proceedings of Sixty-Second Tax Conference, 2010 Tax Conference (Toronto: Canadian Tax Foundation, 2011), 14:1-15.