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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

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”