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The Crown Succeeds on a Motion to Strike a Portion of the Taxpayer’s Pleading: Golini v. The Queen

In Paul C. Golini v. The Queen (2013 TCC 293) the Tax Court of Canada agreed to strike out portions of a taxpayer’s pleading suggesting that a protective reassessment issued by the Canada Revenue Agency (“CRA”) was invalid.

In June 2012, the CRA informed the taxpayer that his 2008 income tax return had been selected for an audit. In the following months, both parties continued to correspond and exchange information. In August 2012, the CRA asked the taxpayer to provide a waiver extending the limitation period to reassess the 2008 taxation year. The taxpayer declined to do so.

In September 2012, the Minister reassessed the taxpayer and informed him that the reassessment was a “protective reassessment;” supporting documentation would be provided upon completion of the audit.

The Crown brought a motion to strike out the allegation that the reassessment was invalid. The taxpayer contended that a “protective reassessment” was inconsistent with the assessing provisions of the Income Tax Act as it was issued solely to allow the Minister additional time to complete an audit.

The Tax Court judge looked to Karda v. HMQ (2006 FCA 238) for guidance on the issue. In that case, the Federal Court of Appeal held that the Minister may issue a protective reassessment where a taxpayer declines to provide a waiver so long as the CRA has completed “some review” and has requested further information. The Tax Court judge held that:

There is no law . . . to the effect that a protective assessment is invalid if issued for the sole purpose of leaving the door open to conduct or continue an audit.

He went on to note that:

. . . the law, I find, is clear that some review by the CRA followed by inquiries for more information and a request for a waiver, subsequently refused, is sufficient for a protective assessment to be a valid assessment. And that is exactly what we have here.

Whenever a taxpayer declines to grant the CRA a waiver, the CRA almost invariably reassesses before the “normal reassessment period” expires.  There is nothing surprising about that.  What is noteworthy here, though, is the willingness of the Tax Court to entertain the Crown’s request to strike out, before trial, an argument put forward by a taxpayer. As we noted in our blog post on the Federal Court of Appeal’s decision in Canadian Imperial Bank of Commerce v. The Queen:

Parties are generally given the opportunity to make whatever arguments they consider necessary to their case with the ultimate determination being made by the trial judge who is in the best position to decide questions of relevance and weight in light of all the evidence.  It is rather unusual for a legal theory, novel though it is, to be taken off the table at such an early stage.  At the same time, courts are increasingly concerned about “proportionality” and are reluctant to allow scarce judicial resources to be spent on matters that are unlikely to have any effect on the outcome of the hearing.

This decision is, therefore, consistent with recent jurisprudence from the Federal Court of Appeal and should reduce the number of issues to be decided at trial.

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The Crown Succeeds on a Motion to Strike a Portion of the Taxpayer’s Pleading: Golini v. The Queen

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.

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Will the Tax Court of Canada entertain a determination of a question of law where the focus is on future assessments?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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This article was first published in the International Tax Review.

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

Taxpayer entitled to disclosure of the “policy” underlying statutory provisions allegedly abused in GAAR cases

On December 20, 2012, the Tax Court ruled on a motion under Rule 52 of the Tax Court of Canada Rules (General Procedure) (the “Rules”) to require the Minister to comply with a demand for particulars specifying how the Income Tax Act (the “Act”) was abused in a General Anti-Avoidance rule (“GAAR”) case.

In Birchcliff Energy Ltd. v The Queen (2012-10887(IT)G), the Minister alleged that the GAAR should apply because the series of transactions (the “Transactions”) undertaken by the taxpayer resulted in a misuse of 10 sections of the Act and an abuse of the Act as a whole. In response, the taxpayer sought an order requiring the Minister to disclose the policy behind each section of the Act that was allegedly abused and how the Transactions abused that policy.

The Tax Court held that the Minister must disclose the object, spirit, and purpose of the provisions of the Act (the “Policy”) that the assessor relied upon in making the assessment. The Minister does not need to disclose the actual Policy that will be argued at trial, or the way that the Policy was abused.

Arguments

The taxpayer argued that in making a GAAR assessment, the Minister must assume as a fact the Policy and an abuse of that Policy. Relying on Johnston v M.N.R. (1948 S.C.R. 486), the taxpayer argued that the Crown had a duty to disclose “precise findings of fact and rulings of law which have given rise to the controversy”. The taxpayer also argued that there was a heightened obligation on the Minister to be specific in cases of misconduct, negligence, or misrepresentation, relying on Chief Justice Bowman’s decision in Ver v Canada ([1995] T.C.J. No. 593). Misuse or abuse, it was argued, belonged in the category of offenses requiring more precise disclosure.

The Minister, on the other hand, argued that the Policy was a conclusion of law, not fact and that only allegations of fact must be disclosed in particulars. The Minister raised a “slippery slope” argument, suggesting that this ruling could require the Crown to explain its legal interpretation of all provisions of the Act in the future. Although the Minister acknowledged that Trustco v Canada (2005 SCC 54) placed the burden of identifying the Policy on the Crown, that burden did not apply to pleadings. The Minister also argued that disclosing the Policy would not help the Appellant because the Minister could still argue a different policy at trial.

Decision

The Tax Court highlighted the unique nature of GAAR, and stated that any disclosure requirements from this case would only apply to GAAR assessments. Justice Campbell Miller specifically pointed to the Crown’s burden to prove the Policy in GAAR cases as evidence of its unique requirements.

Justice Miller separated the elements of the Policy into two distinct categories:

1)      The actual Policy that would be argued and decided at trial (the “True Policy”), and

2)      The fact that the Crown relied on a particular Policy when determining that GAAR should be applied (the “Historical Policy”).

The Court held that the True Policy was a question of law that should ultimately be decided by the court. This policy was open to change throughout the course of litigation and did not need to be disclosed to the Appellant at this stage.

The Historical Policy, however, was held to be “a material fact, not an assumption, but the fact the Minister relied upon x or y policy underlying the legislative provisions at play in the case.” Taxpayers are entitled in pleadings to know the basis of the assessment. Disclosing the Historical Policy would be similar to disclosing the legislation upon which non-GAAR assessments are made. The Court distinguished the Historical Policy from the type of materials to which the taxpayer was denied access in Mastronardi v The Queen (2010 TCC 57), a recent Tax Court decision holding that the Minister did not need to disclose the extrinsic materials on which the Minister relied in determining the Policy. In Mastronardi, the materials sought to be disclosed were evidence that could be used to prove the policy, rather than the material fact of which policy was relied on (evidence itself is not a material fact).

The Historical Policy that must be disclosed is not the Policy of each identified section in isolation. The Minister must identify the collective policy of all of the identified provisions together that the Crown relied on in making the assessment. The Historical Policy should be disclosed under paragraph 49(1)(e) of the Rules as “any other material fact”.

With regards to the Appellant’s request for information on how the Policy was abused, the Court held that it was not required to be disclosed. Abuse is a conclusion of law to be determined by the court based on the Policy and the facts of the case. The Minister did not assume how the Policy was abused as a fact. The Minister concluded, based on the Policy and the facts assumed, that there was an abuse.

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The Tax Court has reiterated that the taxpayer is entitled to know the basis of the assessment made against him.  Such an approach is consistent with principles of fundamental fairness and is entirely in keeping with the letter and spirit of the Rules.

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Taxpayer entitled to disclosure of the “policy” underlying statutory provisions allegedly abused in GAAR cases

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., [2007] 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.

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Federal Court decides that JP Morgan’s judicial review application challenging the Minister’s decision to assess Part XIII tax may proceed

Successful Challenge to Portions of the Crown’s Reply on the Deductibility of Amounts Paid by CIBC to Settle Enron Litigation

On December 19, 2011, the Tax Court partially granted an application by Canadian Imperial Bank of Commerce (“CIBC”) (2011 TCC 568). The motion concerned whether the Crown’s Reply should be struck out, either wholly or in part (there were actually four separate Replies, but all are substantially similar). Associate Chief Justice Rossiter did not strike out the entire Crown pleading, but ordered 98 paragraphs struck out and 92 paragraphs amended from the main Reply (with the same amendments to be made to the other three Replies). The main Reply was 94 pages long with 70 pages of assumptions.

The Tax Court appeals involve the deductibility of amounts paid by CIBC to settle litigation arising from the failure of Enron in 2001. CIBC was named (along with a number of other parties) as a defendant in a pair of law suits filed after Enron went bankrupt. CIBC settled the claims against it in consideration for a payment of $2.65 billion in 2005 and deducted those amounts, along with related interest and legal expenses in computing income for its 2005 and 2006 taxation years.

The Minister of National Revenue denied the deduction of the settlement amounts. CIBC appealed to the Tax Court of Canada. The Crown filed a Reply, and CIBC filed a motion to have the Reply struck out in its entirety. The contentious point is whether the “egregious or repulsive” principle can be used to determine whether expenses are deductible. The concept was referred to at paragraph 69 of the reasons for judgment in 65302 British Columbia Ltd. v. Canada where a majority of the Supreme Court of Canada (per Iacobucci J.) made the following observation:

It is conceivable that a breach could be so egregious or repulsive that the fine subsequently imposed could not be justified as being incurred for the purpose of producing income. However, such a situation would likely be rare and requires no further consideration in the context of this case, especially given that Parliament itself may choose to delineate such fines and penalties, as it has with fines imposed by the Income Tax Act.

On this motion, the Crown argued that it should be open to it to establish that the “egregious or repulsive” principle could also apply in respect of amounts paid in order to settle litigation. CIBC contended that this concept has never been held to apply to settlement amounts and that, as a result, the Reply was fatally deficient.

Associate Chief Justice Rossiter first concluded that part of a pleading should only be struck where it is “certain to fail because it contains a radical defect.” Here, the Crown was trying to use the “egregious or repulsive” principle to justify denying the deduction of amounts paid to settle a law suit rather than amounts laid out to pay fines. The Court acknowledged that the “egregious or repulsive” principle had been developed by the courts in the context of fines, but noted that it could apply to settlement payments, and so the Respondent’s pleadings did have a chance of success. He refused to strike the Crown’s entire pleading as a result.

However, Associate Chief Justice Rossiter found that in the Reply the Crown pleaded evidence, conclusions of law or mixed fact and law, immaterial facts or advanced prejudicial or scandalous claims or claims that were an abuse of process of the Court. In the result, the Court held that portions of the Reply were improper and had to be removed. The Crown was given 60 days to file a less argumentative Amended Reply with the offending portions deleted.

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Successful Challenge to Portions of the Crown’s Reply on the Deductibility of Amounts Paid by CIBC to Settle Enron Litigation

Tax Court of Canada confirms that pleadings will be struck out only in the “clearest of cases”

On December 19, 2011, the Tax Court dismissed a motion by General Electric Canada Company and GE Capital Canada Funding Company (the “Appellants”) in their current appeals (2010-3493(IT)G and 2010-3494(IT)G). The Appellants sought to strike several paragraphs from the Replies filed by the Crown on the basis that the Crown was relitigating a previously-decided matter. Justice Diane Campbell dismissed the motion but gave leave to the Crown to make a small amendment to one of the Replies.

General Electric Canada Company (“GECC”) is the successor by amalgamation to General Electric Capital Canada Inc. (“GECCI”), and GECC had inherited commercial debts owed by GECCI. GECC was reassessed and denied the deduction of fees paid to its parent corporation (“GECUS”) for guaranteeing the inherited debts. However, GECCI had previously litigated the deductibility of those fees and won (see General Electric Capital Canada Inc. v. The Queen, 2009 TCC 563, aff’d 2010 FCA 344). The current appeal involves similar issues, but with different taxpayers (GECC instead of GECCI) and tax years. In their application, the Appellants argued that the Crown was trying to relitigate issues that had been decided in the previous appeal.

The Court first dealt with the Appellant’s contention that res judicata precluded the Crown from having the issues reheard in another trial. Res judicata may take one of two forms: “cause of action” estoppel or “issue” estoppel. For either to apply, the parties in the current matter must have been privy to the previous concluded litigation. The Appellants said GECC had been privy to the decision since both it and GECCI were controlled by a common mind. The Court dismissed that argument since the appeals involve different tax years from those in the previous concluded litigation and, therefore, reflect different causes of action.

The Appellants also argued that it was an abuse of the Court’s process to relitigate the purpose and deductibility of the fees since the debt and the fee agreements were substantially the same as those in the previous concluded litigation. They asked the Court to strike out references to those agreements from the Replies. The Crown’s counter-argument was that the nature of the agreements was a live issue since it was not established that the fee agreements between GECUS and GECC were the same as those with GECCI. The Court agreed and refused to strike the sections of the Replies referring to the agreements.

The Appellants also sought to strike parts of the Replies where the Crown denied facts which the Appellants said had been proven in the previous concluded litigation. Again, the Court noted that the issues in the present appeals were different than those at issue in the previous concluded litigation, and that the Appellants did not show that the facts at issue (which were part of a joint statement of facts in the prior case) had actually been considered by the Court in the prior decision. Since the facts had not been proven they were best left to be determined later at trial.

Further, the Appellants contested two theories reflected in the Replies that they characterized as a fishing expedition. The Appellants stated these theories were not used as a basis for the original reassessment and, therefore, violated the restrictions on alternative arguments under subsection 152(9) of the Act. The Court dismissed this argument, saying that the theories were simply alternative approaches to showing that the guarantee fees paid by GECC were not deductible. The Court held they were alternative pleadings and refused to strike them out. Further, the Appellants also argued that two separate basis for the reassessments (one based on paragraphs 247(2)(a) and (c); the other, on paragraphs 247(2)(b) and (d)) should be pleaded as alternative grounds, since the two parts of that section were inconsistent with one another. This was dismissed on the basis that the two parts were complementary and were drafted in a way so that if both were satisfied, one would take precedence over the other.

Finally, the Appellants argued that they had been deprived of procedural fairness as the CRA had not consulted its own Transfer Pricing and Review Committee with respect to the reassessments, and the Appellants had been unable to make submissions to that committee. The Court held that there was no requirement that the committee consider the matter first and, even if there was, the Tax Court does not rule on administrative matters.

In the end, the Appellants succeeded on one minor point: the Crown will amend one paragraph in one Reply to clarify the distinction between legally binding guarantees and implied guarantees or support. The Crown was awarded costs.

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Tax Court of Canada confirms that pleadings will be struck out only in the “clearest of cases”