Tax litigators expect a fight as CRA boosts budget

Practice groups expect more work as changing rules lead to a more complex dispute-resolution environment
As if it somehow anticipated the Panama Papers leak the following month, the Liberal government announced in March that it would increase its budget allotment for the chronically underfunded Canada Revenue Agency by about $90 million annually over the next five years.

Whether or not the CRA can actually make good on its vow that its half-billion-dollar bonanza will yield $2.6 billion in recovered taxes through increased targeting of tax havens, stepped-up audits of large foreign transfers of money and more intense investigation of consultants selling shelters remains to be seen.

But results are one thing and activity is another. And activity there will be: the CRA is hiring 100 new auditors, increasing its audits of high-risk taxpayers fivefold to 3,000 annually from 600, and ramping up its review of tax shelters to include 200 promoters a year, a tenfold increase over the current rate. The major full-service firms are also beefing up in anticipation of an increased workload.

“It seems that every significant law firm in the country is setting up a tax litigation practice group,” says
Guy Du Pont of Davies Ward Phillips & Vineberg LLP in Montréal. “It’s a big growth area because governments are in need of money and they’re going after it more aggressively.”

But tax boutiques like
Thorsteinssons LLP, which have always been important players in this market, are also preparing for growth.

“Recouping money that’s going outside the country by focusing on offshore tax havens and aggressive tax planning is where we’ll see the most vigorous enforcement, and there’s going to be a lot of litigation around that,” says Tom Boddez of Thorsteinssons in Vancouver.

As it stands, the tax dispute resolution environment is a complicated one, featuring growing complexities and rising costs in a system that is becoming ever more adversarial; challenges presented by the “group appeal” phenomenon; uncertainties introduced by Canada’s commitment to the Organisation for Economic Co-operation and Development’s (OECD) crusade against base erosion and profit shifting (BEPS); and substantive legal issues relating to rectification and the CRA’s duty of care.

Making the system more complicated is the fact that Canada does not have a unified tax court. Rather, the jurisdiction is split between the Tax Court of Canada (TCC) and the Federal Court, with provincial superior courts also figuring into the mix. Underlying it all is an undercurrent of jurisdictional testiness between the Federal Court and the Tax Court of Canada, which carries most of the load. This has spawned important questions about access to justice and judicial efficacy.

The TCC is a superior court of record that has exclusive original jurisdiction over matters arising under a number of federal statutes. The bulk of the appeals to the court from administrative decisions under these statutes relate to income tax, goods and services tax, and employment insurance. The court also hears references from the CRA to provide interpretations of the legislation within its areas of jurisdiction.

But the Tax Court of Canada’s jurisdiction comes with some important limitations. Most significantly, it does not extend to the “fairness” portions of the Income Tax Act and the Excise Tax Act, which grant discretion to the Minister of Revenue to waive penalties and interest. Taxpayers who are seeking this type of relief must apply to the Federal Court.

Put another way, the TCC cannot make decisions on the basis that they will yield a fair result. As a consequence, there are often circumstances where the TCC must acknowledge that it is rendering an unfair result and that it has no choice but to do so.

Self-represented taxpayers who resort to the TCC’s Informal Procedure (IP) bear the brunt of this anomaly. The IP, which represents upwards of 70 per cent of the court’s caseload, is a streamlined, lower-cost process for disputes not exceeding $25,000 for cases where interest only is in issue and where the taxpayer is claiming a business loss not exceeding $50,000. In the IP, taxpayers may represent themselves or be represented by an agent who is not a lawyer. Most procedural rules and rules of evidence are relaxed and most pre-trial procedural steps are eliminated.

Generally speaking, the IP works efficiently and expeditiously — until taxpayers discover that their appeal, or part of their appeal, cannot be dealt with by the TCC.

“This occurs regularly where taxpayers are self-represented, which is the case in many Informal Procedure matters,” says Chief Justice Eugene Rossiter, who currently heads the TCC. “It’s an access-to-justice issue and a process for which I have to apologize to taxpayers.”

As things stand, the apologies will probably have to be issued more frequently. “The CRA is becoming increasingly aggressive in assessing penalties,” says Robert Kepes of Morris Kepes Winters LLP in Toronto.

Particularly popular with the CRA are penalties levied for gross negligence. “The CRA is putting these on the table far more frequently and putting them on the table far sooner for use as a bargaining tool,” says
Steve Suarez of Borden Ladner Gervais LLP in Toronto.

Recently retired chief justice Gerald Rip, one of two judges first appointed when the Tax Court was established in 1983, and now counsel with Spiegel Sohmer in Montréal, describes the taxpayer’s dilemma this way to Lexpert: “When I was on the Bench, I could feel very sympathetic to taxpayers who had no case in terms of changing the assessment but had an arguable case with respect to how they were treated, how the process was administered and to the application of the relief provisions. I would have to tell these taxpayers that I couldn’t do anything for them. But the taxpayer would say, ‘This is a tax court and a tax issue. Why can’t I deal with it now?’ I would try to explain, but in some cases even the time for applying to the Federal Court for relief had expired, and you ended up with the taxpayer just looking at you in disbelief. My view is that we should be able to hear cases where taxpayers claim the CRA has treated them like crap — because most of us on this Bench know how the CRA works.”

It’s not just unrepresented taxpayers, however, who bear the frustration. “Most tax practitioners would prefer an expansion of the Tax Court of Canada’s jurisdiction,” says David Robertson of EY Law LLP in Calgary. “The split jurisdiction is inconvenient, makes things more expensive and has been a frustration going back as far as 20 years ago.”

Indeed, the Tax Court of Canada is an itinerant court – something of a people’s court – sitting in 57 cities for some 44 weeks annually. In contrast, the Federal Court sits only in major centres.

“In places where we don’t have our own facilities, we sit in superior or provincial court premises and, where those aren’t available, we’ll sit in hotels, church halls, municipal offices or even rinks,” Rossiter says. “We’re built for speed and manage our inventory tightly.”

To make things worse, the TCC lacks jurisdiction in other key areas. By way of example, only the Federal Court can review the CRA’s failure to act lawfully when making information demands in tax audits; to issue notices of assessment, reassessments, or determinations or pay uncontested refunds in a timely manner; and to act lawfully in collection matters. The TCC also lacks jurisdiction to deal with late filing of designations or elections, or reassessments issued beyond the expiry of statutory limitation periods.

The situation confounds and frustrates Rossiter. “I have never heard a single, solitary rational argument against having one court deal with all tax matters,” he says. “The public wants it and the Bar wants it.”

Besides, it’s not an expensive proposition. “How many changes can be made where you can say it won’t cost the government any significant amount of money?” Rossiter asks.

Alexandra Brown, formerly with the federal Justice Department and now at Blake, Cassels & Graydon LLP in Toronto, believes there are “good reasons” why “all tax-related functions” should be in the jurisdiction of one court.

“To have the jurisdiction bifurcated isn’t consistent with judicial economy and it creates temptations for forum-shopping,” she says. “Despite the Federal Court of Appeal’s best efforts, clarity is sometimes lacking in where relief should be sought, meaning prudent counsel may have to go to both courts, and that’s not a good use of parties’ resources either.”


The bugbear, apparently, can be found in the Federal Court hierarchy.

“It’s a very sensitive subject about which there has been a great deal of acrimony between the Tax Court and the Federal Court,” former chief justice Rip says. “The Federal Court has forever been pushing the merger of the two courts.”

In 2012, Paul Crampton, who had recently been appointed Chief Justice of the Federal Court, publicly disavowed any plan to revive the merger proposal. He told media that his priority is “working co-operatively” with the Tax Court.

But simultaneously, Crampton (who declined to speak with Lexpert) resisted the Canadian Bar Association’s proposal that some 400 tax-related judicial reviews that his court hears each year be transferred to the Tax Court. He opined that judicial reviews were “different types of decisions” best handled by judges who did judicial reviews on a daily basis.

“The Federal Court feels better qualified to do judicial reviews because administrative law is part of their bread and butter,” Robertson says.

Rip counters that the TCC leans to recruiting judges who have good tax or litigation experience. “You wouldn’t necessarily get that in the Federal Court where judges are back and forth dealing with different areas of the law,” he says.

Muted though the controversy might be by the twin realities of judicial discretion and lawyers’ reluctance to criticize courts in front of which they must advance their clients’ interests, it’s unlikely that it will disappear.

“The judges are fighting over jurisdiction and that remains a divisive issue,” Robertson says.

So much so that not only will the problems arising from bifurcation continue to hover in the background, they’ll most likely get worse.

The reason? The courts are finally starting to respond to demands that the CRA be held accountable for its actions by imposing a duty of care on the tax collector. Most notable is the jurisprudential trend recognizing an ongoing duty of care to taxpayers on the part of tax authorities.

“It will now be easier for businesses and individuals to argue that the CRA and other tax authorities must administer the law in good faith and refrain from behaviour that is abusive or irrational,” says Martin Sorensen of
Bennett Jones LLP in Toronto.

The problem is that they won’t be able to make that argument in the TCC, which has no jurisdiction to deal with alleged breaches of the duty or damages ensuing from those breaches, nor can it provide relief from interest or penalties on the basis of CRA misconduct. Aggrieved taxpayers, then, have no choice but to start from scratch and make their way to provincial superior courts or the Federal Court.

To be sure, the existence of a duty of good faith might make the CRA and other tax authorities somewhat easier to deal with as they suggest that the agency is not at liberty to intimidate and threaten taxpayers as it chooses and has a responsibility to take appropriate care in deciding to take steps against them.

“These decisions should over time result in a difference in the way the CRA treats taxpayers and their rights,” says tax lawyer David Rotfleisch of Rotfleisch & Samulovitch Professional Corporation in Toronto.

The most notable decision, Agence du revenu du Québec c. Groupe Enico inc., turned on the duty of good faith enshrined in Québec’s Civil Code. But the decision is in line with two common-law rulings on the point: both the Federal Court of Appeal’s decision in Canada v. Scheuer, released just weeks before Enico, and the British Columbia Supreme Court’s 2014 judgment in Leroux v. Canada Revenue Agency affirmed that the CRA has a duty of care to taxpayers.

“Generally speaking, the duty of care is well-known to the common law and the principles discussed in Enico are similar to those dealt with in Leroux,” Sorensen says.

Still, Sorensen is careful to point out that Enico featured “outrageous” facts. They included information withheld from the taxpayer, destroyed notes, lost evidence, auditors operating under false pretenses, fraudulent entries in Revenu Québec working papers and revelations about “quotas” imposed on Revenu Québec personnel. “The evidence also showed that Revenu Québec continued to seize assets even after it knew that the assessments against Enico were grossly inflated,” Sorensen says. “It was a perfect storm of facts in favour of a duty of care and it opens a small window in egregious cases and perhaps cases in which CRA assessments and conduct run contrary to its own internal policies.”

But it doesn’t open even the smallest of windows at the TCC, which can’t award damages or grant relief from penalties or interest. The upshot is that so long as taxpayers have to run around to various courts to assert the duty of care, the duty could well remain in the realm of theory, dusted off only when taxpayers have the will and the finances to fight governments.

Indeed, even clients flush enough to be susceptible to multimillion-dollar assessments might conclude that pursuing a claim for breach of duty isn’t worth it.

“I have a successful client who recently got a $50-million assessment based on one of the most insane positions I have ever seen in 23 years of practice,” Boddez says. “We’ve just closed the file and he owes nothing, but he won’t sue for what was clearly a negligent audit because the way the system is structured, he’d just be spending a whole lot of legal fees to try to recover what he paid us.”


Legal fees, in fact, are becoming a concern throughout the tax dispute resolution system. “There’s no question that the expense of litigation has become a much larger issue for all litigants, including governments, than they used to be,” Rossiter says.

As tax disputes become more common, they are also becoming more complex, more lengthy, more costly and increasingly immersed in an environment that lacks the collegiality it had before.

“When I started out, cases rarely took more than two days and usually lasted one half day,” Rip says. “But the GlaxoSmithKline transfer-pricing case went on for 20 years and took up 47 days of trial.”

By way of demonstrating how quickly things are moving, it wasn’t long before the 47-day length-of-trial record was eclipsed: Rossiter recently presided over a 62-day hearing that engaged 120 bankers’ boxes holding 220,000 documents.

If anyone at all is benefitting from this trend, it’s probably the CRA. “They likely don’t mind because they can bleed people to death,” says Jack Blackier of Cox & Palmer in Saint John. “In many cases, it becomes cheaper to write the cheque to the CRA than to pay lawyers.”

As it turns out, transfer-pricing cases are a particular problem, largely because there are no easy ways for companies to take advantage of the rules.

“Recent decisions have made it clear that unsophisticated transfer-pricing schemes won’t work,” says Greg Gartner of Moodys Gartner Tax Law LLP in Edmonton.

Almost by definition, then, transfer-pricing programs and policies must be quite complicated.

“The CRA’s heightened emphasis on transfer pricing is causing taxpayers to document their obligations and transactions correctly,” says
Glenn Ernst of Goodmans LLP in Toronto. “Getting full and detailed transfer-pricing reports is more prevalent than ever.”

In the event of a dispute, of course, the complexities invariably find their way into the courtroom. “The courts are dealing with massive audits and huge money,” says David Chodikoff, who practises with Miller Thomson LLP in Toronto. “The cases are slow to get to court, get bogged down when they get there and require enormous effort to be resolved.”

And if the recent uncertainties created by the federal budget are any indication, things are likely to get worse before they get better. Among the measures announced by the federal government was its intention to adopt certain BEPS transfer-pricing guidelines without amending s. 247 of the Income Tax Act, which articulates the “arm’s-length principle” that is the basic statutory rule governing transfer pricing in Canada. But adopting the international standards without legislative action flies in the face of the Supreme Court of Canada’s pronouncement that the OECD transfer guidelines are not per se law in Canada and subsequent judicial interpretations that enunciate a domestic standard for the arm’s-length principle that differs from the BEPS standards.

“The budget indicates that the CRA intends to effectively ignore the Supreme Court and try to use BEPS transfer-pricing-related recommendations in its interpretation and enforcement of the ITA, a move that quite likely will increase disputes and litigation between multinationals and the CRA,” says
Nathan Boidman of Davies Ward in Montréal.


Resolving matters, not just transfer-pricing matters, at the audit stage would undoubtedly make a serious dent in the litigation explosion. But that’s not happening.

“The gloves are coming off more frequently at this level,” says Claire Kennedy of Bennett Jones in Toronto. “Increasingly, the CRA is leaving it to taxpayers to resolve matters on appeal as opposed to coming up with something fair and reasonable at the audit stage.”

Michael Lubetsky of Davies Ward in Toronto says that the growth in tax disputes is partly the result of a double-edged sword. “On the one hand, there’s certainly a perception that the CRA has become increasingly aggressive and offering a lot of incentives for auditors to step up their assessments,” he says. “At the same time, there have been cutbacks on the availability of technical advisors to assist auditors who are trying to apply what is essentially an incomprehensible statute.”

The CRA’s current structure has also made it difficult to engage directly.

“Audits are done virtually by remote, objections are assigned to intake centres on a random basis as a way of balancing workloads and there’s more of an emphasis on written submissions in the appeals protocol and less face-to-face discussion,” says Carman McNary, who practises with Dentons Canada LLP in Edmonton.

At the same time, requests for documentation from the CRA are becoming more onerous and probing. “We are seeing tax authorities, with increasing frequency, making far-reaching requests where the burden to the taxpayer outweighs the benefits to the auditors,” Suarez says. “Many of these are of questionable relevance and need to be pared back.”

CRA is also turning its attention to information traditionally regarded as confidential. A recent decision of the Federal Court, for example, requiring public companies to disclose the reserves they take for contingent tax liabilities, has the business community and its advisors up in arms.

What Minister of National Revenue v. BP Canada Energy Company does, critics argue, is requires businesses to provide CRA with the very ammunition it requires to challenge a company’s tax returns.

“The reason we find the decision so disturbing is that CRA is looking under taxpayers’ skirts,” Rotfleisch says. “It’s especially offensive because the documents in questions are not being prepared in the usual course of business as company records, but as audit requirements.”


BP is under appeal, but it’s precisely this kind of infighting and the increasing number of large cases that has turned the growth of interlocutory proceedings into one of the more disturbing developments at the TCC.

“Large cases are a growth area, so much so that 10 per cent of the cases we hear involve 90 per cent of the money,” Rossiter says. “When you get cases of that size, you start to get a lot of litigation at the motions stage.”

The court is not happy about it. “Historically the TCC has not been a forum for the procedural wrangling we see in provincial courts,” Brown says. “So there’s a definite trend to judges being critical of parties who are perceived to engage in obstructionist tactics.”

Still, the procedural wrangling is taking a toll on the traditional collegiality of the tax litigation Bar.

“There’s a real concern that when proceedings become as procedurally oriented as they are substantively oriented, some of that collegiality gets lost,” Robertson says.

For its part, the TCC is doing its best to encourage settlement with incentivizing new costs rules, introduced some two years ago, and a proactive approach to settlement conferences. The new rules award 80 per cent of post-offer actual costs to a party who makes a settlement offer that the other party rejects, and the result at trial is better than the offer.

In an effort to give the rules some teeth, the Bench has taken a liberal approach to awarding costs, one based largely on the principle that the tariff is only a starting point. The upshot is that costs awards are beginning to spiral.

“There’s a recent case in which the Crown asked for $535,000 in costs and the court awarded $475,000,” Kepes says. “But for the longest time costs were a secondary consideration because the tariff was so low.”

The expectation is that the TCC will see an increase in settlements and settlements at an earlier stage.

“Previously, it was hard to get the attention of Justice Department lawyers, who are overworked, when we sent in settlement offers,” says Robert McCue, who practises with Bennett Jones in Calgary. “What the new rules do is create an incentive to take a very close look at an earlier stage. Settlement will be discussed much more often before the eve of trial, which is when they tended to happen.”


Hopefully, that’s what will happen. Because the rules are changing, and uncertainty abounds.

The main culprit going forward is likely to be BEPS. The March 2016 federal budget includes various measures aimed at advancing Canada’s commitment to the OECD initiative. The measures include limiting treaty benefits by expanding the application of “back-to-back” interest rules to apply to payments of rents and royalties, to limiting “economically similar” arrangements notwithstanding the form of those arrangements, and to arrangements involving multiple intermediaries. As well, the budget has tightened up the “control exception” to the surplus stripping rules.

Canada will also implement country-by-country reporting, revise its transfer-pricing guidance to ensure it meets the BEPS standard and implement the BEPS minimum standard for the spontaneous exchange of certain tax rulings as well as the common reporting standard for the automatic exchange of information among participating countries.

The CRA has also introduced an Offshore Tax Informant Program (OTIP) that could ramp up the volume of litigation.

“The OTIP offers financial awards to individuals who provide information relating to certain types of ‘major international tax non-compliance,’” says Michael Friedman of
McMillan LLP in Toronto. “Over the past year, it has received 1,920 separate contacts from potential informants under the OTIP, which led to over 200 written submissions and 110 cases that are currently being reviewed.”

The trend of “group appeals,” a phenomenon associated with heavily marketed structured tax products or shelters, is also presenting its own challenges to the TCC.

“There are no mechanisms for class actions in the TCC, so you get hundreds of taxpayers with the same issue but each of whom has to jump through the same procedural hoops to keep their claim alive,” Du Pont says. “The court is doing the best it can, but it’s very hard because the system is designed for the individual taxpayer, whose case is unique in its own way.”

Nor is the group appeal trend likely to abate. “Group appeals are a huge growth area,” Rossiter says. “We’ve brought in rules to deal with them, but they continue to be a challenge.”

Also looming are two rectification cases before the Supreme Court of Canada: the first is from the decision of the Ontario Court of Appeal in Fairmont Hotels Inc. v. Attorney General of Canada and the second is from the decision of the Québec Court of Appeal in Groupe Jean Coutu (PJC) Inc. v. Attorney General of Canada.

Rectification is not a remedy available in the TCC. Still, obtaining rectification from provincial superior courts where the transactions did not achieve specific tax objectives that the taxpayers intended to obtain in undertaking the transactions is now common in Canada.

The CRA isn’t happy about it, hence their appeals in Fairmont and Jean Coutu. The outcome could very well affect the TCC’s caseload.

“A liberal interpretation would confirm rectification applications as a means of fixing problems that could otherwise lead to extensive tax litigation in the TCC,” McCue says.

On the other hand, a narrow interpretation could add considerably to the TCC’s docket. It could also create problems for tax lawyers and planners.

“If the SCC narrows the kind of mistake that can be rectified, it could have a meaningful adverse effect on the tax advisory profession,” says Stephen Ruby of Davies Ward in Toronto. “The more difficult it is to get something rectified, the greater the risk of liability to professionals and their insurers — and we’re talking about cases with damages in the tens of millions of dollars if negligence is established.”

Now there’s incentive for change.