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

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

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

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

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

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

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

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

Bolton Steel Tube: TCC Orders Crown to Reassessment in Accordance with Settlement‏

In Bolton Steel Tube Co. Ltd. v. The Queen (2014 TCC 94), the Tax Court of Canada allowed the taxpayer’s motion requesting an Order that would require the CRA to reassess the taxpayer in accordance with the terms of a settlement agreement. In doing so, the Tax Court discussed certain principles regarding settlement agreements and the resulting reassessments.

In Bolton Steel Tube, the CRA reassessed the taxpayer for its 1994, 1995, 1996 and 1997 taxation years on the basis that the taxpayer failed to report income in each of those taxation years (the “2007 Reassessment”).

In 1996, the taxpayer reported $1.2 million of income. The CRA added approximately $600,000 of unreported income for total income of $1.8 million. During examinations for discovery, the CRA’s representative admitted that approximately $200,000 of the $600,000 increase should not have been made. Accordingly, for the 1996 taxation year, the maximum amount of income the CRA could have added as unreported income was $400,000. The CRA further confirmed this admission in its Reply.

On June 15, 2012, the taxpayer delivered to the Crown an offer to settle which proposed to settle the appeals on the basis that (i) the CRA would vacate the reassessments for 1994, 1995 and 1997, and (ii) the CRA would reassess the 1996 taxation year to add $403,219 to the taxpayer’s income and impose a penalty under subsection 163(2) of the Income Tax Act (the “Act”). The Crown accepted this offer without further negotiation, and the parties entered Minutes of Settlement on these terms.

Following the settlement, the CRA issued a reassessment that calculated the taxpayer’s income for its 1996 taxation year to be $2,266,291, essentially adding $403,219 to the $1.8 million that had been previously assessed (the “2012 Reassessment”). The result was illogical: The agreed amount of unreported income – $403,219 – was added twice, and the $200,000, which the CRA had admitted was not to be added to the taxpayer’s income, was included as well.

In requesting the Order, the taxpayer argued that:

The 2012 Reassessment was not supported on the facts and the law;

The 2012 Reassessment violated the principle that the CRA cannot appeal its own assessment; and

The 2012 Reassessment was made without the taxpayer’s consent, which would be required pursuant to subsection 169(3) of the Act.

The Crown argued that if the 2012 Reassessment was varied or vacated then there had been no meeting of the minds, the settlement was not valid, and the 2007 Reassessment should remain under appeal.

The Tax Court agreed with the taxpayer on all three arguments.

With respect to the first argument, the Tax Court found the CRA’s interpretation of the Minutes of Settlement to be “divorced from the facts and law”. The Crown’s position was unsupportable since settlements must conform with the long-standing principal from Galway v M.N.R. (74 DTC 6355 (Fed. C.A.)) that settlements must be justified under, and in conformity with, the Act. In Bolton Steel Tube, the Tax Court went as far to say “even if both parties consented to settling in this manner, it could not be permitted” and “there is nothing to support the [Crown’s] interpretation and nothing to support the [Crown’s] further contention that the [taxpayer] offered this amount in exchange for other years to be vacated”.

With respect to the arguments surrounding subsection 169(3) of the Act, the Tax Court found that the taxpayer had not consented to having its income increased by the amount in the 2012 Reassessment.

The Crown argued that subsection 169(3) of the Act, which allows the CRA to reassess an otherwise statute-barred year upon settlement of an appeal, also allows the CRA to increase the amount of tax which the CRA could reassess despite subsection 152(5) of the Act. Subsection 152(5) of the Act is the operative provision that prevents the CRA from increasing an assessment of tax. Here, the Tax Court maintained the longstanding principle that a reassessment cannot be issued that results in an increase of tax beyond the amount in the assessment at issue. This is tantamount to the CRA appealing its own reassessment, which is not permitted, and thus renders the 2012 Reassessment void. We note that the Tax Court also considered the 2012 Reassessment to be void on the basis that it was an arbitrary assessment.

The Tax Court rejected the Crown’s argument that the settlement was ambiguous and therefore there was no meeting of minds as would be required for a valid contract. The Crown argued that the settlement was not valid and therefore the years under appeal should remain in dispute. The Tax Court turned to fundamental principles of contractual interpretation and found that the contract validly existed since it could reasonably be expected that the Crown would have known that the addition of $403,219 was to be added to the appellant’s income as originally reported (i.e., $1.2 million) and not to the income amount in the 2007 Reassessment (i.e., $1.8 million).

Accordingly, the Tax Court rejected the Crown’s argument, found that the settlement was valid and that the Minister should reassess on the basis that $403,219 should be added to the taxpayer’s income as originally reported. Since the 2012 reassessment was not valid, and therefore did not nullify the 2007 reassessment, and a notice of discontinuance had not yet been filed, the Tax Court continued to have jurisdiction over the appeal.

The result of this motion was a clear victory for the taxpayer and for common sense. It serves as a reminder that precision is essential when entering into settlement agreements.

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Bolton Steel Tube: TCC Orders Crown to Reassessment in Accordance with Settlement‏