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There’s A Litigation App For That?

We were intrigued to learn that KosInteractive LLC has created the U.S. “Fed Courts” app for Android and Apple devices which contains helpful information about U.S. federal courts rules of procedure and court information. The app provides access to the PACER (Public Access to Court Electronic Records) database, and the procedural rules for appellate, bankruptcy, civil, and criminal proceedings. The federal rules of evidence and the U.S. Supreme Court procedural rules are also available. One drawback – the information isn’t searchable or indexed with hyperlinks.

In any event, there seems to be no Canadian equivalent for litigation or procedural apps.

A quick search in the Apple iTunes stores for “Canada tax” returns 54 results, including an array of federal and provincial tax calculators. ”Canada courts” returns five items, including apps related to the Controlled Drugs and Substances Act, mortgage foreclosures, U.S. Miranda warnings, and a car dealership. A search for “Ontario civil procedure” returns one item, and “Canada tax court” returns zero items.

We are reminded of the very helpful event app developed by the Canadian Tax Foundation that has become a regular feature of the Foundation’s national and regional conferences.

We are confident that Canadian tax professionals would welcome a broader array of court and litigation procedure apps that would provide mobile access to most or all of the court and procedural information we’re stuffing into our oversized litigation bags.

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There’s A Litigation App For That?

Supreme Court of Canada to Release Two Decisions on Tax and Rectification

On Thursday November 28, the Supreme Court of Canada will release its decisions in the companion cases of Agence du Revenu du Québec v. Services Environnementaux AES Inc., et al. (Docket #34235) and Agence du Revenu du Québec v. Jean Riopel, et al. (Docket #34393).

The narrow question on appeal is under what circumstances the Superior Court of Quebec may correct a written instrument that does not reflect the parties’ intentions. More broadly, the issue is how and to what extent the equitable principles of rectification operate in the context of the Quebec Civil Code. These will be the first substantive decisions of the Supreme Court on tax and the doctrine of rectification.

See our previous posts on the cases here and here.

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Supreme Court of Canada to Release Two Decisions on Tax and Rectification

Mark Your Calendars: Tax Litigation Forum – December 11, 2013

As the Canada Revenue Agency becomes increasingly aggressive in pursuit of perceived domestic and offshore tax avoidance, it is more important than ever to be familiar with recent developments in legislation, policy and procedure. David W. Chodikoff (Miller Thompson LLP) and David E. Spiro (Dentons Canada LLP) are, therefore, delighted to chair this tax litigation conference – the first organized by Insight Information.

Leading litigators and clients have been gathered to participate in lively panel discussions covering a wide range of challenging issues – from how to deal with CRA requirements and misconduct to making successful voluntary disclosure applications and fairness requests. You’ll learn about the latest developments in transfer pricing and the GAAR and will find out how project management can help you win your case. Finally, for those cases that can be resolved before trial, his conference will explore when and how to take advantage of the opportunities for settlement. In short, you will leave with the tools to resolve tax controversies more confidently than ever!

Event Details
December 11, 2013
07:45 AM – 05:00 PM EDT
St. Andrew’s Club and Conference Centre
150 King Street West
Toronto, Ontario M5H 4B6

For more information, including a list of Distinguished Faculty members and Event Schedule, click here.

To register, click here.

Mark Your Calendars: Tax Litigation Forum – December 11, 2013

Take a Chance: Judicial Review of the CRA’s Discretionary Power under s. 152(4.2) of the Income Tax Act

In Radonjic v. The Queen (2013 FC 916), the taxpayer brought an application for judicial review of the CRA’s refusal to make certain adjustments to the taxpayer’s tax returns after the normal reassessment period had expired.

In 2003, the taxpayer start playing online poker. After consulting with his accountant, the taxpayer treated his gambling winnings as income in 2004, 2005, 2006 and 2007. Later, he concluded that his gambling winnings were likely not taxable. Accordingly, the taxpayer filed a request for an adjustment under subsection 152(4.2) of the Income Tax Act asking that the income tax he had paid be returned to him.

The CRA denied the taxpayer’s adjustment request. The taxpayer then brought an application for judicial review of the decision to deny the adjustment request.

The Federal Court noted that the standard of review for the CRA’s exercise of discretion under subsection 152(4.2) is reasonableness (see Dunsmuir v. New Brunswick (2008 SCC 9), Caine v. C.R.A. (2011 FC 11), and Hoffman v. Canada (2010 FCA 310)). In other words, the court should intervene only if the decision was unreasonable in the sense that it falls outside the “range of possible, acceptable outcomes which are defensible in respect of the facts and law”.

The Federal Court considered the parties’ positions on the issue and the various court decisions that have addressed the taxation of gambling gains and losses (see, for example, Cohen v. The Queen (2011 TCC 262), and Leblanc v. The Queen (2006 TCC 680)).

The court concluded that the CRA had fully considered all of the taxpayer’s submissions, and that there was no evidence of procedural unfairness or bad faith by the CRA.

However, the court concluded that the CRA had misinterpreted or misunderstood the taxpayer’s activities, and had drawn unreasonable and unsupportable conclusions about the tax treatment of the taxpayer’s gambling winnings:

[51] … The Minister’s exercise of her discretion under subsection 152(4.2) of the Act in this case lacks intelligibility and justification and, in my view, falls outside the range of possible, acceptable outcomes which are defensible in respect of the facts and law.

Overall, the court found that the taxpayer was simply an enthusiastic and ever-hopeful poker player engaged in a personal endeavour.

The court quashed the CRA’s decision and returned the matter to the CRA for reconsideration in accordance with the court’s reasons.

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Take a Chance: Judicial Review of the CRA’s Discretionary Power under s. 152(4.2) of the Income Tax Act

Canada’s Taxpayer Ombudsman Addresses Fear of Reprisal

In the August 2013 edition of Perspectives, Taxpayer Ombudsman J. Paul Dubé highlighted the recent addition of Article 16 to the Taxpayers’ Bill of Rights protecting taxpayers against any possibility of reprisals by the CRA.

Previously, in June 2013, Gail Shea, then-Minister of National Revenue, and Mr. Dubé announced the addition of Article 16 to the Taxpayers’ Bill of Rights:

16. You have the right to lodge a service complaint and request a formal review without fear of reprisal.

In the newsletter, Mr. Dube states,

This right means that if you lodge a service complaint and request a formal review of a CRA decision, you can be confident that the CRA will treat you impartially, and that you will receive the benefits, credits, and refunds to which you are entitled, and pay no more and no less than what is required by law. You should not fear reprisal.

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Canada’s Taxpayer Ombudsman Addresses Fear of Reprisal

Out with the Old, In with the New: Clearwater Seafoods Holdings Trust v. The Queen

In the recent decision in Clearwater Seafoods Holdings Trust (2013 FCA 180), the Federal Court of Appeal considered the scope and purpose of Rule 29(1) of the Tax Court of Canada Rules (General Procedure) (the “Rules”).  When a trust ceases to exist during the course of a tax appeal, with tax liability shifting to a new person, may the new person continue the appeal?  The Court answered that question in the affirmative and unanimously held that this scenario falls within the language and intended purpose of Rule 29(1).

In 2011, Clearwater Seafoods Holdings Trust (the “Trust”) appealed an income tax assessment to the Tax Court of Canada.  In 2012, the Trust transferred all of its assets to Clearwater Seafoods Income Fund, which subsequently transferred the assets to Clearwater Seafoods Incorporated (the “Corporation”).  This transfer occurred in the context of the Trust “converting” to avoid application of the SIFT rules under the Income Tax Act.

At the Tax Court (2012 TCC 186), both parties accepted that the Trust had been terminated as a result of the disposition of all its property; however, this did not automatically bring the income tax appeal to an end.  The issue in Clearwater was whether the tax appeal could be continued with the Corporation as appellant in place of the Trust.  To obtain an order permitting the Corporation to assume the position of appellant going forward, a motion was brought by the Trust pursuant to section 29 of the Rules, which states,

29 (1) Where at any stage of a proceeding the interest or liability of a person who is a party to a proceeding in the Court is transferred or transmitted to another person by assignment, bankruptcy, death or other means, no other proceedings shall be instituted until the Registrar is notified of the transfer or transmission and the particulars of it. [emphasis added]

Once notice has been given to the Registrar, Rule 29 provides that the Chief Justice or a judge designated by him may direct the continuation of the proceeding.  At the Tax Court, the taxpayer brought a motion arguing that the Corporation is the appropriate party to continue the tax appeal as it now owned the property and would be liable if the appeal is unsuccessful.  The Crown argued that the tax appeal should be dismissed for want of an appellant.  The Tax Court held that the matter were not within the scope of Rule 29(1) and the motion was dismissed.  The order was appealed to the Federal Court of Appeal.

The Court of Appeal held that the lower court had construed Rule 29(1) too narrowly.  In arriving at this conclusion, the Court of Appeal addressed the rule’s underlying rationale.  The Court found that the purpose of Rule 29(1) is to deal with instances in which the circumstances of a litigant have changed and special accommodations are required in order to continue the proceeding.  Such changes may include bankruptcy, incapacity due to illness or injury, death of a litigant or the dissolution of a litigant that is a corporation.  The Court also considered such changes to include circumstances where a litigant that is a trust is terminated as a result of the disposition of all of its property.

The Federal Court of Appeal found that the transfer of the property to the Corporation, in effect, placed tax liability on the Corporation and the trustees in the event of an unsuccessful tax appeal.  The termination of the existence of the Trust was found to be within the meaning of “other means” in Rule 29(1).  Consequently, it was held that there was a transmission of liability from the Trust to “another person” by “other means”. The Court held that this scenario falls within the language and purpose of Rule 29(1).  As a result, the appeal was allowed and the matter was sent back to the Tax Court to be reconsidered with a view to directing the continuation of the proceedings.

The decision in Clearwater highlights the Court’s willingness to interpret Rule 29(1) in a broad manner.  It also raises the question of what constitutes “other means” for the purposes of Rule 29.  As a result, it is important for any taxpayer, or party which may acquire tax liability, to consider the implications of Clearwater prior to an income tax appeal.

Out with the Old, In with the New: Clearwater Seafoods Holdings Trust v. The Queen

Waiving rights of objection and appeal: SCC declines to hear the taxpayer’s appeal in Taylor v. The Queen

On August 15, 2013, the Supreme Court of Canada dismissed the application for leave to appeal in Terry E.Taylor v. Her Majesty the Queen (2012 FCA 148).

In Taylor, the issue was whether a signed settlement agreement under which the taxpayer waived his right to appeal was binding. In that case, the taxpayer was assessed for income tax and GST, as well as gross negligence penalties and interest. He signed a settlement agreement under which the Minister of National Revenue would vacate the gross negligence penalties and, in exchange, he would waive his right to object or appeal in accordance with subsections 165(1.2) and 169(2.2) of the Income Tax Act and subsections 301(1.6) and 206.1(2) of the Excise Tax Act. The taxpayer, who did not have counsel advising him at the time, later claimed that he was under duress when he signed the agreement. Having already disposed of the penalties, he went to Tax Court to challenge the amount of tax assessed.

Justice Judith Woods held that the taxpayer’s testimony that he was “scared” and pressured into signing the agreement lacked credibility given his qualifications as a Certified Management Accountant and his extensive business and financial experience. He had ample time to consult with counsel prior to meeting with the CRA. The Tax Court held that the settlement agreement was “freely made” and signed without “undue pressure.”  The Tax Court dismissed the taxpayer’s appeal (2010 TCC 246) and the Federal Court of Appeal affirmed at 2012 FCA 148. As noted above, the Supreme Court of Canada has declined to hear Mr. Taylor’s appeal.

Taylor adds to an existing body of case law on the question of whether, and under what circumstances, settlement agreements between taxpayers and the CRA can be set aside. The Tax Court has held that in certain limited circumstances a settlement agreement may not be binding. For example, in 1390758 Ontario Corporation v. The Queen (2010 TCC 572) and Huppe v. the Queen (2010 TCC 644), agreements were held to be binding so long as they were made on a “principled” basis (see, for example, Daniel Sandler and Colin Campbell, “Catch-22: A Principled Basis for the Settlement of Tax Appeals“, Canadian Tax Journal (2009), Vol. 57, No. 4, 762-86).

Given that a significant portion of tax disputes are settled and never reach the courtroom, professional advisors should ensure that taxpayers understand the implications of signing settlement agreements under which they relinquish rights of objection or appeal.

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Waiving rights of objection and appeal: SCC declines to hear the taxpayer’s appeal in Taylor v. The Queen

The importance of a notice of objection: Salisbury v. The Queen

In Salisbury House of Canada Ltd. et al. v. The Queen (2013 TCC 236), the Tax Court of Canada reiterated the importance of the statutory preconditions that must be met before a taxpayer may appeal to the Court. These statutory requirements should be kept in mind by taxpayers who wish to ensure their disputes are heard on the substantive merits rather than dismissed for procedural reasons before they have an opportunity to argue their case.

In Salisbury, the corporate taxpayer operated several restaurants in the Winnipeg area. The company was assessed additional GST for the period February to June, 2006 but did not object to those assessments. Around the same time, a new board of directors was elected. Due to financial difficulties, the company made a proposal under the Bankruptcy and Insolvency Act and attempted to negotiate an agreement with the CRA pertaining to the GST arrears. The parties eventually agreed that a portion of the GST liability would be paid. Importantly, at this point, no directors’ liability assessments had been issued under s. 323 of the Excise Tax Act. Payment was remitted, but the directors sought to have their potential liability for tax determined “by a court of competent jurisdiction”.

The company and the individual directors each filed a Notice of Appeal in the Tax Court. In response, the Crown brought a motion to dismiss the appeals pursuant to paragraph 53(b) of the Tax Court of Canada Rules (General Procedure) on the grounds that (inter alia) the appeals were scandalous, frivolous or vexatious.

Under section 306 of the Excise Tax Act, a taxpayer must file a notice of objection before a Notice of Appeal may be filed in the Tax Court. In Salisbury, the GST assessments against the corporate taxpayer had not been challenged by way of objection and there had been no assessments issued against the directors.  The Minister argued that the appellants had no statutory right of appeal because the requirements of section 306 had not been met.

The Tax Court granted the Minister’s motion and dismissed the appeals. Since no notices of objection had been filed by the company, this precluded an appeal from the original GST assessments. In respect of the appeals by the individual directors, the Court held that they too could not succeed – no assessments had been issued, and no notices of objection filed.

The Salisbury decision is consistent with a long line of jurisprudence reflecting the requirement that taxpayers must satisfy the statutory preconditions before appealing to the Tax Court. In Roitman v. The Queen (2006 FCA 266), the Federal Court of Appeal stated that a court “does not acquire jurisdiction in matters of income tax assessments simply because a taxpayer has failed in due course to avail himself of the tools given to him by the Income Tax Act.” More recently, in Goguen v. The Queen (2007 DTC 5171), the Tax Court reiterated that, as “a matter of law, the failure of the [taxpayer] to serve a notice of objection on the Minister deprive[s] the Tax Court of Canada of the jurisdiction to entertain an appeal in relation to the assessment” (see also Whitford v. The Queen (2008 TCC 359), Bormann v. The Queen (2006 FCA 83), and Fidelity Global Opportunities Fund v. The Queen (2010 TCC 108)).

Salisbury reminds corporate and individual taxpayers of the need to obtain proper advice from tax professionals with respect to their rights and obligations under the Excise Tax Act and the Income Tax Act. This is all the more important in cases where the corporation is experiencing financial difficulty and/or contemplating protection under the Bankruptcy and Insolvency Act (i.e., as the CRA may be a primary creditor). In Salisbury, the directors may not have been personally liable for corporate taxpayer’s GST liability. However, because of the manner and timing of the payment of GST arrears, their “appeal” to the Tax Court was defeated on procedural rather than substantive grounds and they were, unfortunately, precluded from presenting their case.

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The importance of a notice of objection: Salisbury v. The Queen

Tax Court of Canada issues a comprehensive ruling on privilege issues and the appropriate exercise of remedies to address deficient lists of documents

In a recent Tax Court of Canada ruling on a motion heard in Imperial Tobacco Canada Limited v. The Queen, 2013 TCC 144 the Court considered a motion for an Order directing the Appellant to attend and be cross-examined on its List of Documents pursuant to subsection 82(6) and paragraph 88(a) of the Tax Court of Canada Rules (General Procedure) (the “Rules”). Justice D’Arcy heard and dismissed the motion, choosing instead to exercise other remedies available to the Court under section 88 of the Rules. A portion of the Respondent’s motion dealt with privileged documents. In ruling on these documents, the Court addressed several issues in the area of solicitor-client privilege and made a notable finding that email communications between the taxpayer and its lawyer lost privileged status as a result of the taxpayer’s accountant being included on the communications.

Background

The Appellant in Imperial Tobacco is a subsidiary of British American Tobacco p.l.c. The Appellant acquired preferred shares of affiliated subsidiaries (the “Affiliated Companies”) and the Minister disallowed the Appellant’s deductions of dividends received from those Affiliated Companies which was appealed to the Tax Court of Canada.

The Respondent had concerns with the Appellant’s List of Documents, specifically with respect to identifying necessary metadata (electronic data relating to specific documents referred to in Schedule “A” including author, when the document was created and history of changes to the document), deleted documents referred to in Schedule “C”, and privileged documents listed in Schedule “B”. As a result of these concerns, the Respondent moved for an Order allowing cross-examination on the Appellant’s List of Documents in order to gather further information relevant to its concerns. The Respondent relied upon the following provisions under the Rules:

82(6)   The Court may direct a party to attend and be cross-examined on an affidavit delivered under this section.

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88.       Where the Court is satisfied by any evidence that a relevant document in a party’s possession, control or power may have been omitted from the party’s affidavit of documents, or that a claim of privilege may have been improperly made, the Court may,

(a) Order cross-examination on the affidavit of documents,

(b) Order service of a further and better affidavit of documents,

(c) Order the disclosure or production for inspection of the document or a party of the document, if it is not privileged, and

(d) Inspect the document for the purpose of determining its relevance or the validity of a claim of privilege.

Other Remedies under Section 88 should be considered before Cross-examination

Although the Court acknowledged that cross-examination should be considered if it has concerns that a List of Documents does not satisfy the requirements under the Rules, it agreed with the Appellant that subsection 82(6) takes away the automatic right to cross-examine. Instead, the Court found that all of the remedies under section 88 must first be considered before issuing an Order for cross-examination on a List of Documents. In this case, the Court found that perceived deficiencies in the Appellant’s List of Documents could be better addressed by ordering the service of a further and better List of Documents. The Court went on to also make specific orders which required the parties to exchange information to pinpoint what documents the metadata would be required for, and to work towards an agreement on search terms to resolve the deleted documents concern.

The Court’s Analysis and Rulings in respect of Privilege Issues

Since the parties agreed to provide the Court with a book of privileged documents, Justice D’Arcy was able to address the privilege concerns without the need for cross-examination through the remedy available to the Court under paragraph 88(d) which permits the Court to inspect a document for the purpose of determining a claim of privilege.

Several privilege issues were raised by the Respondent which afforded the Court an opportunity to canvass the applicable law in making its ruling. The issues and the Court’s determination of each are listed below:

1. Internal communications between the Appellant’s employees – The Court discussed the circumstances in which internal communications between employees of a company may be privileged, namely, if the communications reflect confidential legal advice provided by the company’s lawyer or if the lawyer marks or makes a note on a disseminated document. The Court then went on to analyze what specific internal communications were privileged.

2. Solicitor-client communications disclosed to employees of the Affiliated Companies – The Court discussed common interest privilege under this issue and explained that privilege may be maintained where one party to a commercial transaction provides privileged documents to another party of the transaction to further their common interest of having the transaction concluded. In this case, the Court concluded that several documents exchanged between the Affiliated Companies were privileged on this basis.

3. Solicitor-client privileged documents disclosed to an accountant – This issue centered on disclosure of legal communications by the Appellant, its counsel and the Affiliated Companies to PriceWaterhouseCoopers Australia (“PWC Australia”). Relying on the principles espoused by the Exchequer Court in Susan Hosiery Limited v. M.N.R., the Appellant argued that solicitor-client privilege extended to the communications with PWC Australia on the basis that PWC Australia’s input was necessary to the provision of legal advice by counsel. The Court accepted this principle of law but found a lack of evidence establishing that PWC Australia’s role extended to any function which could be said to be integral to the solicitor-client relationship. Therefore, the disclosure of the documents to PWC Australia constituted disclosure to a third party which amounted to waiver of privilege. The Court placed some emphasis on the fact that there was no evidence of any accounting information that could only be provided by PWC Australia.

4. Implied waiver – The Respondent argued that there was implied waiver of solicitor-client privilege since the Appellant, in denying that tax avoidance was the principle purpose for its investments, placed its state of mind in issue and any legal advice obtained to help form that state of mind was waived. The Court disagreed, and found that state of mind waiver only applies where a party relies on legal advice as part of its claim or defence which had not been put into issue by the Appellant in this appeal. In that regard, the Court noted that nowhere in the Appellant’s pleadings was there any reference to legal advice previously obtained.

5. Legal advice vs. business advice – Communications between a lawyer and client will only be privileged if it is in the course of providing legal advice, not advice relating to purely business matters. The Court found that the issue does not arise in the appeal.

Concluding Remarks

Justice D’Arcy’s decision reflects what the Court likely regarded as a pragmatic approach to the exercise of remedies available to it. It is open to the Court to order cross-examination, but other less costly steps are available to it, and should be first considered. This aspect of the decision should be considered by counsel before deciding to pursue cross-examination. Counsel should first aim to reach agreement on other steps to address concerns relating to production issues.

The privilege discussion contained in this decision highlights the range of such issues that arise in tax appeals. The decision highlights that internal client communications and external communications with accountants and other experts needs to be carefully managed. Counsel should discuss privilege issues with clients at the front end of litigation so they are alert to the pitfalls of waiver.

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Tax Court of Canada issues a comprehensive ruling on privilege issues and the appropriate exercise of remedies to address deficient lists of documents

Sales of condominium units under audit by Canada Revenue Agency

A Canada Revenue Agency (“CRA”) audit initiative is targeting taxpayers who have recently sold condominium units they did not occupy or occupied for only a short period of time (the “CRA Condo Project”).

The CRA is reassessing some of these dispositions on the basis that the condo was sold in the course of business, treating the profit as income (instead of capital gains) and, in some cases, assessing gross negligence penalties under subsection 163(2) of the Income Tax Act. In doing so, the CRA may be incorrectly reassessing some taxpayers whose gains are legitimate capital gains and that may be subject to the principal residence exemption (click here for a discussion of the principal residence exemption).

Consider this example. A taxpayer signs a pre-construction purchase agreement for a condo in 2007.  In 2009, the unit was completed and occupied by the taxpayer, before the entire development was finished and registered in land titles.  Land titles registration occurs in 2010, but shortly thereafter the taxpayer sells the condo for a profit.  Ordinarily, one would conclude the condo was held on account of capital and the gain would be at least partially exempt from tax on the basis that condo was the taxpayer’s principal residence.  The CRA may be inclined to reassess on the basis that land title records show the taxpayer on title for only a short time, as though the taxpayer had intended to merely “flip” the condo rather than reside in it.

This assessing position may be incorrect because the buyer of a condo does not appear on title until the entire condominium development is registered.  In fact, several years can pass from the date of signing the purchase agreement to occupancy to land titles registration – and, accordingly, the taxpayer’s actual length of ownership will not be apparent from the land title records.

This type of situation could cause serious problems for some taxpayers. If a taxpayer is audited and subject to reassessment on the basis that their entire gain should be taxed as income, the taxpayer will need to gather evidence and formulate arguments in time to respond to an audit proposal letter within 30 days, or file a Notice of Objection within 90 days of the date of a reassessment.

Taxpayers could respond to such a reassessment by providing evidence that they acquired the condo with the intent that it would be their residence, and that the subsequent sale was due to a change in life circumstances.  Taxpayers may wish to gather the following evidence to support such claims:

  • Purchase and sales agreements;
  • Letter or certificates granting permission to occupy the condo;
  • Proof of occupancy, such as utility bills, bank statements, CRA notices, identification (such as a driver’s license) showing the condo as a residence; or
  • Evidence of a change in life circumstances which caused the condo to no longer be a suitable residence, including:
    • Marriage or birth certificates;
    • A change of employer or enrollment in education that required relocation; or
    • Evidence showing the taxpayer cared for a sick or infirm relative, or had a disability that precluded using a condo as a residence.

Taxpayers should be prepared to provide reasonable explanations for any gaps in the evidence.  If a taxpayer wishes to explore how best to respond in the circumstances, they should consult with an experienced tax practitioner.

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Sales of condominium units under audit by Canada Revenue Agency

Supreme Court dismisses leave application in Johnson v. The Queen

On March 21, 2013, the Supreme Court of Canada dismissed (with costs) the application for leave to appeal in the case of Donna M. Johnson v. Her Majesty The Queen.

The issue in Johnson was the tax treatment of receipts from a Ponzi scheme. The Tax Court (2011 TCC 540) allowed the taxpayer’s appeal and held that the receipts were not income from a source for the purpose of paragraph 3(a) of the Income Tax Act. The Federal Court of Appeal (2012 FCA 253) reversed the lower court’s decision, allowing the Crown’s appeal.

I commented on the decisions of the Tax Court and the Federal Court of Appeal in the March 2013 Ontario Bar Association Tax Section newsletter.

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Supreme Court dismisses leave application in Johnson v. The Queen

Nuances of a tax appeal make it unlike a typical civil trial

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.

In the March 15, 2013 issue of The Lawyers Weekly, I discuss some of the ways a tax appeal differs from a typical civil trial.

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Nuances of a tax appeal make it unlike a typical civil trial

A pointed observation by the Federal Court of Appeal on the CRA’s approach to proposed legislation

The recent Federal Court of Appeal decision of Edwards v. The Queen (2012 FCA 330) includes an interesting observation dealing with the Canada Revenue Agency’s policy with respect to proposed legislation.

In Edwards, the taxpayer was involved in a charitable donation scheme. Essentially, the taxpayer was able to obtain a charitable donation tax credit in an amount greater than his outlay or gift. The taxpayer was one of approximately 8,000 taxpayers that had been reassessed, and Edwards was the lead case for eight other appeals.

In the Tax Court, the taxpayer brought a motion for an adjournment of the hearing pending the enactment of proposed amendments to the Income Tax Act. The proposed amendments would be retroactive to when they were first announced. They may have allowed the taxpayer to claim all or a portion of the denied credit.

The CRA had been applying the proposed amendments as if they were law. However, the CRA refused to apply the amendments in the taxpayer’s case. The CRA took the view that the rules did not apply in his situation. As this was an administrative position on proposed amendments rather than law, the taxpayer could not challenge this decision.

The Tax Court denied the taxpayer’s adjournment request (2012 TCC 264).

The Federal Court of Appeal held that the motions judge made no error in denying the application for adjournment. At the time of the hearing of the motion it was not clear if the amendments would be enacted. However, the amendments were subsequently included in a bill to amend the Income Tax Act that received first reading on November 26, 2012. The Federal Court of Appeal found that this new information was a sufficient basis for reversing the motions judgment and granting the adjournment.

In obiter, Justice Evans noted that “there seems something fundamentally unfair in the CRA’s administration of proposed amendments to the Income Tax Act for the past ten years as if they were already law.”

Another example is proposed section 56.4. It has been in draft form since 2005. The proposed rule governs the tax treatment of restrictive covenants. As a matter of existing statute and case law, until proposed section 56.4 is enacted, it is arguable that restrictive covenants should receive the tax treatment described in case law such as the decision of the Federal Court of Appeal in Manrell v. the Queen (2003 FCA 128).

However, advisors and clients – mindful that the proposals will likely become law with retroactive effect – instead find themselves complying with legislative proposals that change over time and impose compliance burdens that are not clear. Proposed section 56.4 includes election provisions referencing prescribed forms that have not actually been prescribed. Taxpayers must satisfy themselves that they have provided sufficient supporting information, a matter over which the CRA retains discretion.

Sometimes the administration of proposed law for long periods of time becomes itself the subject of legislative proposals. For example, for close to a decade there were proposed changes to section 94.1, which deals with certain offshore investments. Ultimately, the proposed changes were withdrawn. Ironically, this has caused the need for new proposed legislation to provide a mechanism for relief for taxpayers who had complied with the unenacted original proposals.

Worse still, taxpayers and advisors must sometime rely only on press releases describing proposed legislation in arranging their tax affairs. For example, recent changes to rules respecting “stapled securities” were announced on July 20, 2011, with intended effect for some taxpayers one year from that date. The proposed legislation itself was released mere days after the intended effective date on July 25, 2012. To echo Justice Evan’s comments there seems to be something “fundamentally unfair” about the proposed laws a taxpayer must comply with being released days after compliance must begin.

It is hoped that the rather pointed remarks by Justice Evans lead to a review by the Department of Finance and the Canada Revenue Agency of this unsatisfactory state of affairs.

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A pointed observation by the Federal Court of Appeal on the CRA’s approach to proposed legislation

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 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.

*  *  *

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).

*  *  *

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

Canada Revenue Agency Toronto Centre Tax Services Office Describes Current Audit Issues

At today’s Canada Revenue Agency Toronto Centre Tax Professionals Group Breakfast Seminar (November 14, 2012), the CRA provided an update on a number of current audit issues.

The CRA was represented by Sal Tringali, Regional Technical Advisor of Aggressive Tax Planning, and James McNamara, Manager of International Taxation and Aggressive Tax Planning Audit Division from the Toronto Centre Tax Services Office. The discussion was moderated by Jacques Bernier (Baker McKenzie LLP) and Rachel Gervais (BDO Canada LLP).

The audit issues highlighted by the panel included the following:

GST/HST

  1. Recapture input tax credit
  2. ITC allocation % – mixed supplies
  3. Financial services
  4. Imported supplies
  5. Reinsurance/loading
  6. Loyalty reward points
  7. VDP – Related parties

Income Tax

  1. Artificial capital losses
  2. Loss trading
  3. Surplus strips
  4. Offshore bank accounts held by individuals
  5. Donation arrangements
  6. International transactions
  7. S. 85 rollovers
  8. RRSP appropriations
  9. Tax-free savings accounts (TFSA)

Additionally, the CRA made the following comments:

    • The CRA’s access to/requests for accountants’ working papers remains a “hot topic”. Generally speaking, the CRA will first ask the taxpayer for information/documents, after which the CRA may request information/documents from the taxpayer’s accountants. The CRA’s objective is to perform high-quality audits, and access to complete information is required to do so.
    • The CRA reminded taxpayers of its recent announcement that the CRA will not assess a taxpayer’s return where the taxpayer has claimed a charitable donation and the alleged gift is made as part of a donation arrangement. The delay in assessing the return could be two years or more (see Jamie Golombek’s recent article on the subject).
    • The CRA has appealed the Tax Court’s decision in Guindon v. The Queen to the Federal Court of Appeal. In light of the Tax Court’s decision, the CRA is currently considering its options in respect of the assessment of third party penalties.
    • The CRA has considered the application of third party penalties in 185 cases. In 71 of those cases the penalty was applied, resulting in the imposition of $79 million of penalties. In 50 cases the penalty was not applied, and 64 cases are ongoing.
    • The CRA will continue to revoke e-file privileges where a tax preparer is subject to a penalty, even where a penalty against a single tax preparer may result in the revocation for his or her entire firm.
    • The CRA referred to the recent Supreme Court decision in GlaxoSmithKline v. The Queen and stated that it intends to follow the new OECD guidelines on transfer pricing and the hierarchy of pricing methods. The CRA said that it did not expect to release any formal communication to the public on this issue, but Information Circular IC 87-2R “International Transfer Pricing” may be updated to reflect this position.

UPDATE: After the seminar, the CRA informed us that it intends to follow the guidance in the recently updated OECD Guidelines and will be issuing a Transfer Pricing Memoranda (TPM) on the matter to the public. This TPM will reflect a recently released internal Communique on the same subject and will be made available in the near future.

    • The CRA clarified that Tax Earned By Audit (“TEBA”) remains a metric for measuring ”tax at risk”, but it is not used to measure the performance of an auditor. Rather, the CRA measures the performance of auditors based on six major elements: (i) planning the audit, (ii) conducting the audit, (iii) applying the appropriate legislation/policy, (iv) the end product of the audit, (v) professionalism in the audit, and (vi) timeliness of completion of the audit.
    • The CRA plans to convene face-to-face meetings with approximately 160 large businesses (i.e., annual sales over $250 million) as part of the CRA’s large business audit project. The CRA will continue to risk-assess all large businesses/entities annually.
    • The CRA intends to clear a backlog of approximately 1,300 audit files so that it may assess the most recent taxation year and the immediately preceding taxation year for most businesses by 2015-16.
    • The CRA reiterated that issues that arise during the audit process should be raised with the auditor, after which it may be appropriate to involve the auditor’s team leader. If the issue cannot be resolved at that level, it would be appropriate to raise the issue with the auditor’s manager or the assistant director of audit at the particular TSO.

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Canada Revenue Agency Toronto Centre Tax Services Office Describes Current Audit Issues

CRA Provides Update on Audit Priorities and Activities

At the Canadian Tax Foundation’s recent Ontario Tax Conference (October 29-30), the Canada Revenue Agency provided an update on its current audit priorities and activities as part of the conference’s “Tax Administration Panel“.

The CRA was represented by Fiona Harrison, Manager of the Resources Section at the CRA’s Income Tax Rulings Directorate, and Jeff Sadrian, National Director of the CRA’s Large Business Audit Programs.

In the course of the presentation, the CRA discussed a variety of issues (see the “Tax Administration Panel” conference slides), including “red tape” reduction, the CRA’s trust audit project, Regulation 105 waivers, ABIL claims, and omission penalties under s. 163(1). The CRA confirmed that it determines audit priorities based on the “highest risk”, and that it is continuing its “intelligence-based risk assessment” of taxpayers to determine which files will be selected for audit.

Other highlights included:

  • Folios – The CRA considers many existing Interpretation Bulletins to be out of date. The CRA intends to reorganize the information in the existing publications in new Folio chapters (i.e., all information relating to specific subjects will be “grouped” together). The CRA plans to update the Folios on an on-going basis, and the first 10-12 Folio chapters are likely to be published before the end of 2012.
  • Entity Classification - In a reversal of an earlier position (see, for example, CRA Document No. 2011-0415141E5 “Tax status of a German Family Trust” (August 4, 2011)), the CRA will once again accept requests for rulings on the classification of foreign entities.
  • Inter-Provincial Trusts – Where a trust claims to be resident, and pays tax, in one province, and the trust is later reassessed as resident in another province, the CRA will reassess the trust only for the difference between the tax paid in the first province and the tax owing in the second province.
  • U.S. LLCs – The CRA continues to disagree with the Tax Court’s decision in TD Securities (USA) LLC. v. The Queen (2010 TCC 186). The CRA’s view is that a fiscally-transparent U.S. LLC does not qualify as a resident of the U.S. for the purposes of the Canada-U.S. Tax Treaty, and is not a “qualifying person” under Article XXIX-A of the Treaty.
  • Section 56(2) – The CRA stated that it is aware of “elaborate arrangements” utilized to divert business income to family members. The CRA stated that, where such arrangements include the use of a trust, section 56(2) may be applied in respect of distributions from the trust provided the requirements of the provision are otherwise met (see Neuman v. The Queen (98 D.T.C. 6297 (S.C.C.)). In other words, the CRA may apply s. 56(2) to the actions of a trustee.

(The Tax Administration Panel conference slides are republished with permission of the Canadian Tax Foundation.)

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CRA Provides Update on Audit Priorities and Activities

Gross Negligence and Settlement Offers

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.

Costs

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.

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Gross Negligence and Settlement Offers

Velcro Canada – Clarification on Cost Awards

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:

[16] 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. …

[17] 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.

 

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Velcro Canada – Clarification on Cost Awards