Taxpayer Challenges CRA Income Tax Pleadings
Lancan Investments Inc v The Queen (2015 TCC 27) was the latest battleground in the war on Canada Revenue Agency’s ("CRA") aggressive behavior and resulted in a small victory for taxpayers who face overbroad allegations from CRA, which continues to insist that it has the right to go on "fishing expeditions".
In Lancan, a motion was made by the taxpayer's Canadian Income Tax lawyer to strike certain paragraphs from the Minister’s Reply (i.e. the Minister’s response to the taxpayer’s appeal to the Tax Court of Canada). In the alternative, the taxpayer requested an order for particulars from the Tax Court of Canada for the Minister to particularize all facts relied upon with respect to a residency allegation.
The paragraph at issue (the “Residency Allegation”) reads as follows:
"Alternatively, (the Minister) says that at all material times (the foreign entity) was a resident of the Principality of Liechtenstein by reason of its management and control being in that jurisdiction, rather than a resident of the Netherlands."
The motion to strike was quickly dismissed by the Tax Court of Canada, as the test to strike parts of a Reply is whether it is "plain and obvious" that the action cannot succeed even if the facts alleged are true. Here, the Tax Court of Canada stated that the mere statement that the management and control of the foreign entity was in Liechtenstein would, in its widest sense, disclose reasonable grounds to oppose the appeal of the taxpayer with regards to the Residency Allegation. The taxpayer had not met the high standard of demonstrating that the Residency Allegation of the CRA had no prospect of success.
Demand for Particulars
The Tax Court of Canada’s analysis of the Minister’s response to the Demand for Particulars arrived at a very different result. Upon being served a Demand for Particulars by the taxpayer, the Minister had essentially refused to answer, pleading firstly that the Residency Allegation was purely an expression of fact and thus the taxpayer was asking for evidence in support of the allegation. Secondly, the Minister argued that the taxpayer already possessed knowledge of the facts and so further particulars were not necessary.
The Tax Court of Canada agreed with the taxpayer that the Residency Allegation was a mixed question of fact and law (as opposed to purely fact); the Residency Allegation involved a question of whether a set of facts satisfy the relevant legal tests, which has been held by the Supreme Court of Canada to be a mixed question of fact and law. Moreover, there are several tests used in Canadian law to help determine where the management and control of an entity resides – de jure control, de facto control, through related groups, etc. On this point, the Minister went as far as to suggest that if the taxpayer was concerned about a "fishing expedition", then the Residency Allegation provided the Minister "a license to fish". The court unequivocally disagreed, and stated that "the parameters of the "fishing licence" must be set within the issues properly pleaded with their material facts". The Tax Court of Canada agreed with the taxpayer that the Residency Allegation was too wide and imprecise, and held that to let the Residency Allegation stand without particulars would be to declare "open season" rather than a defined "licence".
More generally, the Tax Court of Canada re-stated the purpose of pleadings; pleadings are to define the issues in dispute between the parties for the purposes of production, discovery and trial. What is required of a party when pleading is to set forth a concise statement of the material facts upon which the party intends to rely. Material facts are those facts which, if established at trial, will tend to show that the party pleading is entitled to the relief sought.
Secondly, CRA argued that the taxpayer already possessed knowledge of the facts it was seeking in the Demand for Particulars. The law is well established that where the party demanding particulars already has knowledge of said particulars, the court will not order them to be provided. However, the Tax Court of Canada could not find any evidence either in the taxpayer’s pleadings or affidavits to support the CRA’s contention that the taxpayer possessed knowledge of the facts it sought, nor could the Tax Court find anything within the CRA’s summary of the taxpayer’s affidavit that indicated the taxpayer’s knowledge of the foreign entity’s residency. This summary by CRA represented the entirety of its evidence regarding the taxpayer’s knowledge. In essence, without adducing its own evidence CRA made the claim that the taxpayer should "ordinarily assume" that a foreign entity’s residence is where it was created. Unfortunately for CRA, the determination of residence is not nearly that simple and the Tax Court additionally held that the CRA was effectively trying to characterize its submission (that is, the summary of the taxpayer’s affidavit) as evidence of the taxpayer’s knowledge. Accordingly, the Tax Court of Canada held that the taxpayer’s knowledge could not, in this case, be a bar to their Demand for Particulars.
Cost Award for Taxpayer Against CRA
Lancan is another display of the court making attempts to constrain the increasingly aggressive positions taken by CRA in its pursuit of tax revenues. This case highlights an increased scrutiny that the courts are focussing on the overbroad and unreasonable demands and pleadings that CRA places on taxpayers. The prize for the taxpayer in Lancan was costs in the amount of $8,000 ($9,000 was sought) and an order for the Minister to provide particulars with respect to the Demand for Particulars. In granting costs, the Tax Court wrote, "The (taxpayer) was clear that all it really wanted were the requested particulars. The law on particulars is quite established and clear and the (Minister’s) arguments to the contrary were, to speak frankly, very unconvincing".
It will be interesting to see how this type of situation will be treated in the future, given the recent rash of cases that argue the existence of a duty of care owed by the CRA to an individual taxpayer. The duty has been held to exist in some cases, but the scope of the duty has been extremely narrow and causation has proven difficult to establish. Although the facts of Lancan did not give rise to a duty of care, it reflects the growing sentiment in the tax community that CRA’s aggressiveness must be kept in check. Contact one of our top Toronto income tax litigation lawyers for assistance with any income tax litigation matter to fight CRA.
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