The U.S. Supreme Court’s Fall term began on October 7, and there has been no shortage of recent articles on the docket and Judges of the Court. In a previous post, David Spiro noted a remarkable piece on U.S. Supreme Court Chief Justice John Roberts’ advocacy practice before he was appointed to the Court, and in a recent issue of New York Magazine, Justice Antonin Scalia provided his candid views on advocacy and judging.
I first heard of John Roberts Jr. when he was nominated to the United States Supreme Court as Chief Justice. I watched the coverage on C-SPAN which replayed a seminar that he gave to a group of law students on advocacy. I was quite impressed – but not as impressed as I was after reading this article from The American Lawyer magazine. Appellate advocates have much to learn from the Chief Justice of the United States:
On September 26, 2013, the Canadian Tax Foundation Young Practitioners Group (Toronto) convened a panel discussion titled “GAAR at 25: Lessons Learned & Current Challenges” on the General Anti-Avoidance Rule (“GAAR”) in section 245 of the Income Tax Act (“ITA”).
The panelists included Justice Karen Sharlow (Federal Court of Appeal), Justice Patrick Boyle (Tax Court of Canada), Phil Jolie (formerly of the Canada Revenue Agency), Ed Kroft (Blake, Cassels & Graydon LLP), Patricia Lee (Department of Justice) and Shawn D. Porter (Deloitte LLP and formerly at Department of Finance).
The general view of the panelists was that the potential application of GAAR in a specific case is very fact-dependent, and that the jurisprudence on the legal analysis continues to evolve. In the future, the focus will remain on how to interpret the “misuse and abuse” test within section 245.
Impact of GAAR
The panel discussed whether the GAAR has had an impact in deterring taxpayers from engaging in aggressive tax planning. Phil Jolie was of the view that it has not been a major deterrent as some abusive transactions are still not caught under GAAR, whereas Ed Kroft and Shawn D. Porter noted that the GAAR has had somewhat of a “chilling” effect in tax planning, particularly with public companies concerned about reputational risk.
There was a general consensus among the panelists that there is an element of a “smell test” in the GAAR. When evaluating whether GAAR should apply, Justice Boyle admitted there is an element of using one’s “nose” or getting in touch with one’s “spidey sense” and Justice Sharlow noted that she would determine if something “weird” was happening before undertaking the legal analysis as to whether the GAAR may apply.
These comments, made in jest by the panelists, convey the difficulties of analyzing complex transactions to determine whether a situation fits within the object and spirit of the Act under GAAR.
The other panelists noted that this may raise difficulties for tax practitioners who are asked to provide GAAR opinions to clients. The panelists advised that prudent counsel should address the evolving nature of GAAR jurisprudence in any opinion to a client on an issue where the GAAR could be engaged.
Patricia Lee noted that the Department of Justice is currently litigating 44 cases where GAAR is a “live” issue. The cases include the following types of transactions:
- Value shifting and capital loss creations;
- Reverse attributes with trusts;
- Base averaging of shares sold to a spouse;
- Surplus stripping and, in particular, cross-border surplus stripping;
- Manipulation of adjusted cost base of property;
- Acquisition of tax credits and change in control; and
- Leveraged donation cases.
The panelists concluded that, even after 25 years, there remains a degree of uncertainty in respect of the engagement and application of the GAAR.
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:
 … 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.
Will the Tax Court of Canada entertain a determination of a question of law where the focus is on future assessments?
In Sentinel Hill Productions IV Corporation v. The Queen (2013 TCC 267), Justice Judith Woods of the Tax Court of Canada said no. In so doing, she shed light on the requirements for making an application for a determination of a question of law under Rule 58 of the Tax Court of Canada Rules (General Procedure).
Rule 58(1) states:
58. (1) A party may apply to the Court,
(a) for the determination, before hearing, of a question of law, a question of fact or a question of mixed law and fact raised by a pleading in a proceeding where the determination of the question may dispose of all or part of the proceeding, substantially shorten the hearing or result in a substantial saving of costs, or
(b) to strike out a pleading because it discloses no reasonable grounds for appeal or for opposing the appeal,
and the Court may grant judgment accordingly.
The question proposed by the appellants involved the issue of whether notices of determination under subsection 152(1.4) of the Income Tax Act issued in respect of certain partnerships for 2000 and 2001 should be vacated and the appeals allowed on the basis that the Minister subsequently concluded that the partnerships did not exist for these years. Importantly, the Court found that “the focus of the Proposed Question is on whether the Minister of National Revenue is now statute barred from issuing reassessments to partners by virtue of subsection 152(1.8) of the Income Tax Act.” (para. 7)
The Court decided not to allow the Rule 58 application to proceed as it did not meet the two conditions in Rule 58(1)(a). First, the statute-barred issue had not been raised as an issue ”by a pleading”. Second, the proposed question would not have disposed of or shortened the proceeding or saved costs. Although the validity and correctness of an assessment can be determined by the Tax Court of Canada, the proposed question would have challenged the validity of assessments not yet issued and, therefore, the determination of the question of law (whether the Minister is statute-barred from issuing future assessments) would not have disposed of or shortened the proceeding or saved costs.
Federal Court of Appeal deals a blow to the Canada Revenue Agency: Full disclosure must be made on ex parte applications
On February 21, 2013, the Federal Court of Appeal released two decisions related to the obligations of the Minister of National Revenue when making ex parte applications under subsection 231.2(3) of the Income Tax Act (the “Act”) for judicial authorization requiring taxpayers to produce certain information and documents relating to customers. In Minister of National Revenue v. RBC Life Insurance Company et al., 2013 FCA 50, the FCA affirmed the decision of the Federal Court (reported at 2011 FC 1249) cancelling four authorizations issued by the Federal Court in relation to customers of the Respondent companies who had purchased a particular insurance product that has been described as “10-8 insurance plans”. In Minister of National Revenue v. Lordco Parts Ltd., the FCA adopted its reasoning in RBC and again affirmed a judgment of the Federal Court cancelling an authorization that had required information in respect of certain employees of the Respondent.
In both cases, the FCA reaffirmed the Minister’s “high standard of good faith” and the powers of the Federal Court to curtail abuses of process by the Crown.
In RBC, the Minister argued that the facts that it failed to disclose on its ex parte application before the Federal Court were not relevant to the applications. Reviewing the judgment of the Federal Court, the FCA concluded that the Minister failed to disclose the following facts:
- The Department of Finance’s refusal to amend the Act;
- Information in an advance income tax ruling;
- CRA’s decision to “send a message to the industry” to chill the 10-8 plans; and
- The GAAR committee had determined the plans complied with letter of Act.
The FCA held that the Federal Court’s finding that these facts were relevant was a question of mixed fact and law and the Minister had not demonstrated palpable and overriding error by the Federal Court judge. At a minimum, this suggests the Crown may have to disclose information of the sort included in the enumerated list. Examining that list is interesting and suggests a requirement to include in the disclosure to the Federal Court judge hearing an ex parte application facts related to legislative history and intent including discussions about potential problems and possible legislative “fixes”, internal analysis of issues within the CRA including other advance income tax rulings, motivations on the part of the CRA and its officers and agents that may extend beyond auditing the particular facts, and previous analysis of the facts known to the CRA and indications that those facts might support compliance with the Act and inapplicability of the GAAR. That is a very extensive list, and it is encouraging to know that Crown obligations extend into each of these areas.
Further, the FCA held that even if the Federal Court on review of an ex parte order determined that the Minister had a valid audit purpose, it was open to the Federal Court to cancel the authorization based on the Minister’s lack of disclosure. Somewhat surprisingly, the Minister argued that section 231.2(6), unlike section 231.2(3), did not allow for judicial discretion. Once the statutory conditions are established, the Minister argued, the Federal Court judge MUST NOT cancel the authorizations, no matter how egregiously the Crown acted. The FCA rejected this argument, reaffirming the importance of judicial discretion and the duty of the Minister to act in good faith:
 In seeking an authorization under subsection 231.2(3), the Minister cannot leave “a judge…in the dark” on facts relevant to the exercise of discretion, even if those facts are harmful to the Minister’s case: Derakhshani, supra at paragraph 29; M.N.R. v. Weldon Parent Inc., 2006 FC 67 at paragraphs 153-155 and 172. The Minister has a “high standard of good faith” to make “full disclosure” so as to “fully justify” an ex parte order under subsection 231.1(3): M.N.R. v. National Foundation for Christian Leadership, 2004 FC 1753, aff’d 2005 FCA 246 at paragraphs 15-16. See also Canada Revenue Agency, Acquiring Information from Taxpayers, Registrants and Third Parties (issued June 2010).
The Minister’s argument, the FCA held, also runs contrary to the inherent power of the Federal Court to “redress abuses of process, such as the failure to make full and frank disclosure of relevant information on an ex parte application” (para 33):
The Federal Courts’ power to control the integrity of its own processes is part of its core function, essential for the due administration of justice, the preservation of the rule of law and the maintenance of a proper balance of power among the legislative, executive and judicial branches of government. Without that power, any court – even a court under section 101 of the Constitution Act, 1867 – is emasculated, and is not really a court at all. (para 36)
Overall, the RBC decision strongly reaffirms the role of the Federal Court in ensuring the Minister acts in good faith when making ex parte applications. Given the broad powers granted in subsection 231.2(3) and elsewhere in the Act, it is reassuring to know that the Courts can, and will, protect taxpayers and citizens generally by ensuring that the CRA puts all relevant information before the Court when it seeks to exercise those powers.
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.
Federal Court decides that JP Morgan’s judicial review application challenging the Minister’s decision to assess Part XIII tax may proceed
In a decision released on November 26, 2012 in JP Morgan Asset Management (Canada) Inc. v. Minister of National Revenue and Canada Revenue Agency (Docket T-1278-11), Justice Leonard Mandamin of the Federal Court dismissed the Crown’s appeal of an order by Prothonotary Aalto in JP Morgan Asset Management (Canada) Inc. v. Minister of National Revenue and Canada Revenue Agency in which the Crown moved unsuccessfully to strike out a judicial review application on the basis that the taxpayer had no possibility of success in seeking to set aside the decision of the Minister of National Revenue (the “Minister”) to assess Part XIII tax in a manner contrary to the Minister’s own policy.
This decision is the latest in a series of defeats for the Crown on this issue. Since the decision of the Supreme Court of Canada in Canada v. Addison & Leyen Ltd.,  2 S.C.R. 793, there has been a vigorous debate around the limits of judicial review of Ministerial action involving the decision to issue an assessment and the scope of section 18.5 of the Federal Courts Act which reads as follows:
Despite sections 18 and 18.1, if an Act of Parliament expressly provides for an appeal to the Federal Court, the Federal Court of Appeal, the Supreme Court of Canada, the Court Martial Appeal Court, the Tax Court of Canada, the Governor in Council or the Treasury Board from a decision or an order of a federal board, commission or other tribunal made by or in the course of proceedings before that board, commission or tribunal, that decision or order is not, to the extent that it may be so appealed, subject to review or to be restrained, prohibited, removed, set aside or otherwise dealt with, except in accordance with that Act.
The Minister has consistently intepreted the decision of the Supreme Court in Addison & Leyen and section 18.5 of the Federal Courts Act as precluding judicial review of the Minister’s decision to issue an assessment. Thus far, however, the Crown has been largely unsuccessful in striking out such judicial review applications in Federal Court. See, for example, the decision of Prothonotary Aalto in Chrysler Canada Inc. v. Canada and the decision of Justice Hughes on appeal in Chrysler Canada Inc. v. Canada.
By way of background, the Minister assessed Part XIII tax against JP Morgan in respect of fees it had paid to non-resident affiliates between 2002 and 2008. JP Morgan applied for judicial review of the Minister’s decision to assess it for amounts payable under Part XIII of the Income Tax Act. In particular, JP Morgan alleged that in exercising discretion to assess for years other than the current year and the two immediately preceding years
. . . CRA did not consider, or sufficiently consider, CRA’s own policies, guidelines, bulletins, internal communiqués and practices which would otherwise have limited assessments to the current tax year and the two (2) immediately preceding years. CRA thus acted arbitrarily, unfairly, contrary to the rules of natural justice and in a manner inconsistent with CRA’s treatment of other tax payers.
The Crown moved to strike the application for judicial review, relying on section 18.5 of the Federal Courts Act. Citing his earlier decision in Chrysler Canada, the Prothonotary dismissed the Crown’s motion. He held that JP Morgan’s judicial review application dealt with:
. . . the discretion to assess as described in various policies of CRA. That decision to apparently depart from policies and assess is subject to judicial review and is the type of situation that is contemplated by Addison & Leyen. The ITA provides that the Minister “may” assess not “shall” assess which connotes a discretionary decision. The decision of the Minister to apparently depart from policies is not otherwise reviewable [by the Tax Court of Canada] and therefore is subject to judicial review.
Consistent with his earlier decision in Chrysler Canada, the Prothonotary held that “JP Morgan only seeks judicial review of the decision to reassess which is alleged to be contrary to policies of CRA which were in place. No attack on the reassessments is in play.” In his view, the case was about the Minister’s discretion to assess, not the assessments themselves.
Justice Mandamin dismissed the Crown’s appeal of the Prothonotary’s decision as he did not find that the Prothonotary’s Order was clearly wrong in that the exercise of discretion was based upon a wrong principle or a misapprehension of the facts and there was no improper exercise of discretion on a question vital to the case arising with the Prothonotary’s dismissal of the Crown’s motion to strike.
It is not yet known whether the Crown will appeal the decision of Justice Mandamin in JP Morgan, but it would not be surprising in light of the fact that several Crown motions to strike such judicial review applications are currently before the Federal Court.
In my recent blog post on the Newmont Canada Corporation decision I examined the importance that the Federal Court of Appeal attached to credible evidence put forward by taxpayers in tax appeals. The recent decision of Justice Woods in the Tax Court in Bruno v. The Queen is a good illustration of a fair and balanced approach to weighing that evidence.
The taxpayer, Mrs. Bruno, had a business that specialized in supplying custom window coverings. During the 2007 and 2008 taxation years she employed two of her children in the business on a part-time basis and paid them (in the aggregate) $18,000 and $7,000, in each respective year, for their services.
Justice Woods summarized the evidence as follows:
 In the 2007 taxation year, Ms. Bruno reported income from the business in the amount of $11,944. In the 2008 taxation year, she reported a loss from the business in the amount of $16,963.
 Ms. Bruno’s two children were 15-16 and 13-14 in the years at issue and helped out in the business on weekends and holidays.
 According to Ms. Bruno’s evidence, the younger child did less skilled tasks such as cleaning and answering phones, and the older child did mainly clerical work. Both children also spent time learning sales.
 Ms. Bruno entered into evidence a summary of the hours worked and wages earned by the children. Wages were payable at the rate of between $10 and $12 per hour. The summary showed that the children generally worked store hours on both weekend days during 2007 and on one weekend day during 2008, as well as on holidays in both years. The reduction in the hours worked in 2008 was explained by Ms. Bruno on the basis that the business was not doing as well in that year.
 The wages were not paid by cheque. Instead, Ms. Bruno paid for some of the children’s personal expenditures which in aggregate are approximately equal to the wages shown on the summary. According to Ms. Bruno’s testimony, the expenditures were luxury items that the children chose to purchase out of the money that they had earned. A list of the expenditures with a brief description was kept by Ms. Bruno.
 Ms. Bruno stated that her accountant advised her that she could not take a deduction for expenditures on the children’s basic needs, but that she could take a deduction for luxury items. She said that she followed this advice and kept track of the expenses that would qualify.
 Ms. Bruno testified that she could veto any of the children’s purchases that were inappropriate but that she usually approved them.
The Crown’s position was short and to the point:
 At the outset, I would comment that the Crown did not argue that the wages were unreasonable based on the services performed and there was virtually no cross-examination of Ms. Bruno on this point. I will therefore accept that the amounts are reasonable.
 The Crown argued that the expenditures are not deductible because they are personal or living expenditures of Ms. Bruno and the children did not have sufficient discretion over the funds.
Justice Woods dismissed the Crown’s arguments that the children did not have sufficient discretion over the application of the funds:
 As for the Crown’s argument that the children did not have sufficient discretion over the funds, this argument is based on the decision of Beaubier J. in Bradley v The Queen, 2006 TCC 500, 2006 DTC 3535. Paragraph 9 of that decision reads:
 But in a related family, parent-child situation, payment must be made and deposited as it would be to a stranger. The payee must receive and control the alleged payment in his or her name and be able to use it for his or her benefit without any further control by the payer. That did not happen in this case.
 This comment suggests that the children must have complete discretion over the expenditures made. I would respectfully disagree with this and note that Bradley is not a binding precedent since it was an informal procedure case. I see nothing wrong with parents having a veto over expenditures made by their children.
Her conclusion on this point seems unimpeachable. There is little merit in the suggestion that a minor child must have entirely unfettered discretion as to what to do with his or her earnings in order for those amounts to constitute the child’s income. Would it be any less the child’s income if the parents could veto a decision by the minor to purchase a pit bull or pay for hang-glider lessons?
On the broader issue whether wages paid to children were deductible, Justice Woods relied upon the Symes decision of the Supreme Court of Canada:
 In considering the interplay between s. 18(1)(a) and (h), the majority decision in Symes concluded that the prohibition for personal expenditures in s. 18(1)(h) does not apply to an expenditure that was laid out for the purpose of earning income. Justice Iacobucci stated, at page 6014:
Upon reflection, therefore, no test has been proposed which improves upon or which substantially modifies a test derived directly from the language of s. 18(1)(a). The analytical trail leads back to its source, and I simply ask the following: did the appellant incur child care expenses for the purpose of gaining or producing income from a business?
 Accordingly, if a taxpayer incurs an expense for the purpose of gaining or producing income from a business, the deduction will not be prohibited pursuant to s. 18(1)(h) on the basis that it also has a personal benefit to the taxpayer.
 Applying this principle to the facts in this case, if the children are owed wages in reasonable amount, a deduction may be claimed if the wages are paid in the form of purchasing luxury personal items chosen by the children.
Justice Woods then turned to what was undoubtedly the most difficult aspect of this case: weighing and assessing the taxpayer’s evidence.
 Turning to the facts of this case, the difficulty that I have with Ms. Bruno’s argument is that the evidence about the expenditures was not sufficiently detailed for me to be satisfied, even on a prima facie basis, that all the expenditures were made for the children’s benefit, let alone that they were for luxury items.
 The evidence concerning the nature of the expenditures consisted mainly of Ms. Bruno’s oral testimony and the list that she prepared. As for the oral testimony, it is self‑serving and not sufficiently detailed for me to be satisfied on most of the expenditures. As for the accounting records, a great many of the descriptions of the expenditures were simply too general to be of great assistance.
 Based on the evidence as a whole, I am satisfied that some of the expenditures are luxury items for the children’s benefit. However, the evidence is not detailed enough for me to determine which items qualify. It is appropriate in these circumstances, where the appeal is governed by the informal procedure, for the Court to make a rough estimate. On that basis, I propose to allow a deduction for 50 percent of the amounts claimed.
On the one hand she accepted that the services were provided; that the children’s labour actually constituted a tangible benefit to the business. On the other hand the taxpayer had not put forward a sufficiently strong case to persuade Justice Woods that there was not an element of personal benefit to the parents. As a result she split the difference and allowed 50% of the salary expenses claimed.
While the Bruno decision is an informal procedure case and involved relatively small amounts, in my view it clearly illustrates the difficulty a trial judge has in assessing the evidence of a credible witness dealing with difficult or imprecise facts. It further demonstrates the importance of careful preparation of witnesses and the documentary evidence that must be introduced. Finally, it shows once more that counsel must have a finely-tuned ear to anticipate and deal with the types of issues that will likely concern the trial judge.
It’s been just over four months since the Supreme Court of Canada (the “SCC”) heard oral argument in The Queen v. John H. Craig (see our prior blog post for coverage of the hearing and background on section 31), the only section 31 restricted farm loss case to reach the SCC since the oft-criticized Moldowan v. R., 1977 DTC 5213.
Result: Moldowan has been overruled. It took an uncharacteristically short period of time for the SCC to render its judgment – the unanimous decision emphatically stated that “Moldowan cannot stand.”
Justice Rothstein delivered the reasons, which prescribe a new analysis to be undertaken when a taxpayer needs to determine if his or her income from farming activities (such as a horse racing or breeding business), when combined with some other source of income (such as employment or business income) constitutes a “chief source of income.” If this test is satisfied, then the taxpayer may deduct the full amount of any losses from the farming operation against the other source of income, without restriction. If the test is not satisfied, then section 31 restricts the amount of the deductible loss in any given taxation year to $8,750.
The New Test: The new test outlined by the SCC is still a fact-based analysis to be applied to the particular circumstances of the taxpayer, and has two steps:
Step 1: At the outset, a determination needs to be made that the farming business is in fact a business (a source of income from which losses may be deducted), as opposed to a personal endeavour. This test is enunciated in Stewart v. Canada (2002 SCC 46) as the “commercial manner” test, stating that the farming operation is a business if there is no personal or hobby element; or if there is a personal or hobby element, then the venture must be undertaken in a sufficiently commercial manner “in accordance with objective standards of businesslike behaviour” in order to be considered a business.
Step 2: Once it is determined that the farming operation is a business, the taxpayer is entitled to full deduction of farming losses against another source of income if it is determined that farming and the other source of income is his or her chief source of income, based on the following factors, taken together: the amount of capital invested in farming and the other source of income; the income from each of the two sources of income; the time spent on the two sources of income; and the taxpayer’s ordinary mode of living, farming history and future intentions and expectations. To be successful, it must be shown that the taxpayer has invested significant funds and has spent considerable time attending to the farming business and that the taxpayer places significant emphasis on both the farming and non-farming sources of income. Further, it is not necessary that income from the farming business exceed income from the other source of income – this fact is irrelevant to the analysis.
The new test could be described as the “significant endeavors” test – which is much more palatable than the defunct ‘reasonable expectation of profit’ test or ‘three classes of farmer’ test that has now been buried along with Moldowan. RIP.
In the recent case of McMillan v. Canada, the Federal Court of Appeal has reaffirmed the onus of proof rules in tax appeals. While the rules were never particularly unsettled at the federal level, the somewhat anomalous decision of the British Columbia Court of Appeal in Northland Properties v. The Queen in Right of the Province of British Columbia, appeared to cast doubt on prior Federal Court of Appeal pronouncements as well as the decision of Justice L’Heureux-Dubé in Hickman Motors Ltd. v. Canada. In Northland, the B.C. Court of Appeal took issue with the concept, articulated by Justice L’Heureux-Dubé in Hickman, that the onus was on the taxpayer to “demolish” the assumptions pleaded by the Minister by means of raising a prima facie case at which point the burden shifts to the Minister to prove the assumptions on the balance of probabilities:
 Before us, counsel for the Crown made persuasive submissions on the issue of the so-called “prima facie” standard: L’Heureux-Dubé J.’s use of “prima facie” was made in the context of a case in which the Crown had not called any evidence whatsoever; it was relying solely on its assumptions. It is certainly possible in such circumstances that a prima facie case, or even one with “gaps”, would be sufficient to displace the Crown’s assumptions, but the prima facie standard described by Justice L’Heureux-Dubé should not be interpreted as having altered the usual standard of proof in tax cases: see the comments in Sekhon v. Canada,  T.C.J. No. 1145 at para. 37; and Hallat v. The Queen (2000),  1 C.T.C. 2626 (F.C.A.).
The facts in McMillan are uncomplicated and not particularly interesting. The taxpayer had a business in the Dominican Republic and claimed a number of expenses in connection with that business. The Tax Court denied most of the expenses claimed on the basis that they were not proven by the taxpayer. The taxpayer appealed to the Federal Court of Appeal and her appeal was dismissed on the basis that she did not demonstrate any material error on the part of the Tax Court judge.
The interesting part of the decision is the Federal Court of Appeal’s articulation of the rules relating to onus of proof in tax appeals:
 Before concluding these reasons, we note that the appellant did not raise in her memorandum of fact and law any issue with respect to the Judge’s statement at paragraph 19 of the reasons, and repeated at paragraph 21, that the appellant “has the initial onus of proving on a balance of probabilities (i.e. that it is more likely than not), that any of the assumptions that were made by the Minister in assessing (or reassessing) the Appellant with which the Appellant does not agree, are not correct.” In our respectful view, it is settled law that the initial onus on an appellant taxpayer is to “demolish” the Minister’s assumptions in the assessment. This initial onus of “demolishing” the Minister’s assumptions is met where the taxpayer makes out at least a prima facie case. Once the taxpayer shows a prima facie case, the burden is on the Minister to prove, on a balance of probabilities, that the assumptions were correct (Hickman Motors Ltd. v. Canada,  2 S.C.R. 336 at paragraphs 92 to 94; House v. Canada, 2011 FCA 234, 422 N.R. 144 at paragraph 30).
Thus, the Federal Court of Appeal has once again embraced the prima facie standard as the test that must be met by a taxpayer to displace or demolish assumptions pleaded by the Minister. While there may be a different standard applicable in provincial tax appeals in British Columbia, the reaffirmation of the prima facie standard by the Federal Court of Appeal is welcome news in federal tax appeals.
Reuters: Corporations Face Long Odds in Tax Cases Heard by the United States Supreme Court – Situation Brighter in Canada
Reuters recently reported a study showing that corporations face very long odds in tax appeals heard by the United States Supreme Court. There were 919 income tax cases in the Supreme Court of the United States from 1909 to 2011. 364 of those cases involved corporations. In “abuse” cases, the government won 61% of the time. In other cases, the government won 68% of the time. The real story is likely much grimmer since the statistics show that the US Supreme Court only grants review in about 2% of leave applications.
The Canadian Supreme Court heard 356 income tax cases between 1920 and 2003. Of these, the statistics show that the government won 223, or roughly 2/3. The record of Supreme Court tax cases between 2004 and 2012 is essentially similar. While an exact breakdown of corporate cases is not available, anecdotal evidence suggests that the success rate of corporations is roughly 1/3 (a more detailed analysis will be available in the future).
While the Canadian experience appears superficially to mirror the American statistics, a very different story is disclosed by Canadian leave to appeal statistics.
As the chart demonstrates, roughly 12% of leave applications are granted in Canada. Thus, corporations and other taxpayers may have as high as 6 times more likelihood of success in a tax appeal before the Supreme Court of Canada than in cases before the Supreme Court of the United States.
The cards are on the table – Supreme Court of Canada hears argument on whether to confirm or overrule Moldowan
Were your ears ringing this morning? They might have been if you are a racehorse owner or breeder in Canada, or if you are any other type of farmer who earns income from farming and some other source of income and are thus subject to section 31 of the Income Tax Act (the “Act”).
Section 31 of the Act is the restricted farm loss rule that operates to restrict the deductibility of your full farming losses against other sources of income if farming or a combination of farming and some other source of income is not your “chief source of income.”
For the past 35 years, section 31 has been applied to taxpayers on the basis of the Supreme Court of Canada’s decision in Moldowan v. R., 1977 DTC 5213 (S.C.C.), which has resulted in section 31 being one of the most litigated provisions of the Act and replete with confusion, ambiguity and inconsistent results. Finally, the Supreme Court of Canada granted leave in The Queen v. John R. Craig, which was heard this morning by a seven judge panel (Chief Justice McLachlin and Justice Fish were absent). For our earlier blog post on the case (including the factum filed by each party), click here.
The argument took two hours to complete. In the first hour the Court heard argument from counsel representing the Canada Revenue Agency (“Crown Counsel”), which was divided equally into two distinct sets of submissions organized by issue, and argued in succession by two Department of Justice lawyers.
The first issue addressed by Crown Counsel was its assertion that the legal doctrine of stare decisis was misapplied by the Federal Court of Appeal when it decided Craig, which, in the Crown’s submission, suggested that if Moldowan was applied in the manner desired by the Crown, then the case should have ended there with a Crown victory. Madam Justice Abella and Mr. Justice Rothstein took charge of this issue and put Crown Counsel to task with several related questions.
Justice Abella was very active in her questioning and emphasized that the evolution of the principles of statutory interpretation over the course of time makes it appropriate for outdated concepts to be reviewed. Further, the Supreme Court of Canada is THE venue for addressing any inconsistencies and is charged with the task of adjusting the principles for future application if the updated approach yields a different outcome.
It was also emphasized by both Justice Abella and Justice Rothstein that it is appropriate for lower courts to indicate that there is a problem with a prior precedent or an approach to interpretation, since that is the only way the record can be built and the matter brought before the Supreme Court of Canada for final resolution. That’s why they are there.
It was also noteworthy that Crown Counsel stated that the main issue to be decided was stare decisis, whereas Justice Rothstein was clear in his comments that the Supreme Court of Canada is free to overrule itself, and emphasized to Crown Counsel that the real question is whether Moldowan is right or wrong in the face of so much judicial and academic criticism. Those are the submissions he wanted to hear.
The second half of Crown Counsel’s submissions focused on the assertion that the Moldowan analysis of section 31 is correct and should not be disturbed.
Other tidbits from the panel during Crown Counsel’s submissions was Mr. Justice Moldaver’s comment that the ‘government is quite happy with Moldowan’ and Justice Abella’s comment that ‘farming is inherently unreliable as a source of income’ emphasizing the complexity of dealing with farming in the context of tax law. Justices LeBel, Karakatsanis and Cromwell also engaged Crown Counsel with questions during argument.
Mr. Craig’s counsel (“Taxpayer Counsel”) spent his hour focusing on Moldowan and why it needs to be overruled, given current principles of statutory interpretation, its unfairness to taxpayers and emphasizing the better approach taken by the Federal Court of Appeal in Gunn v. R., 2006 DTC 6544 (F.C.A.), which was followed by the Federal Court of Appeal in Craig. Further, it was submitted by Taxpayer Counsel that Mr. Craig would be successful with respect to the section 31 issue even upon strict application of the Moldowan principles.
The Justices were quite engaged in this discussion, which elicited questions or comments from Justices Abella, Moldaver, Cromwell, Karakatsanis, Deschamps and LeBel, all primarily directed at the wording of section 31 and how sense can be made of its wording to create fairness and certainty.
Taxpayer Counsel spent very little time on the stare decisis issue on the basis that, in its submission, the real issue is the correct interpretation of section 31.
After exactly two hours of argument, the far reaching financial implications on racehorse owners, breeders and other part-time farmers is now in the hands of the highest Court in the land to determine the future application of section 31, once and for all. The judgment is expected to be rendered within the next six to twelve months. Stay tuned.
For further background on this issue and a more comprehensive analysis of the history of section 31 prior to the appeal of Craig to the Supreme Court of Canada, click here.
Justice Leslie M. Little, recently retired from the Tax Court of Canada, was interviewed by Tony Sheppard for the Fall 2011 edition of the Tax Newsletter of the University of British Columbia Faculty of Law. Justice Little enjoyed a remarkable career with government, in private practice and then with the Tax Court. An interview well worth reading.