Published: December 14, 2023
Lessons for Canadian Taxpayers in Tax Litigation
Introduction: The Canada Revenue Agency’s Right to Make Factual Assumptions in Tax Disputes
For the most part, in Canadian tax disputes, the Canada Revenue Agency may make factual assumptions—that is, assume the facts favouring the CRA’s position without proving that those facts are true—and the taxpayer bears the initial burden of disproving the CRA’s factual assumptions.
Because the taxpayer usually bears the burden of disproving the Canada Revenue Agency’s factual assumptions, the procedural rules of tax litigation require the CRA’s pleadings to state the factual assumptions that the CRA made “when making the assessment.” This requirement ensures that the taxpayer’s Canadian tax-litigation lawyer knows exactly which factual assumptions to disprove in the Tax Court of Canada trial.
Of course, when issuing a tax assessment, the CRA must also apply Canada’s tax laws and reach a legal conclusion. But these are legal arguments, not statements of fact. Thus, when listing the Canada Revenue Agency’s factual assumptions, the CRA’s tax-litigation pleadings cannot include statements about legal conclusions or statements about mixed fact and law.
Yet in practice, the Canada Revenue Agency’s tax-litigation pleadings often mistakenly identify legal conclusions and statements of mixed fact and law as “assumptions of fact.” Canada’s Federal Court of Appeal recently issued two seemingly contrary decisions involving this exact situation. In Canada v. Preston, 2023 FCA 178, the Federal Court of Appeal decided to let the CRA’s defective pleadings stand. By contrast, in Canada v. Adboss, Ltd., 2023 FCA 201, the court ordered the CRA’s Canadian tax-litigation lawyer to delete a legal conclusion from the factual-assumption section of the pleadings.
After examining the Federal Court of Appeal’s Preston and Adboss decisions, this article seeks to reconcile the reasoning underlying these decisions. It then extracts lessons for Canadians involved in tax litigation and offers pro tax tips from our expert Canadian tax-litigation lawyers.
Canada v. Preston, 2023 FCA 178
The Preston case involved three taxpayers—two individuals and a trust. The individuals were non-resident beneficiaries of the Canadian-resident trust. The beneficiaries, with the assistance of expert Canadian tax-planning lawyers, implemented a tax plan to avoid the $12 million in capital-gains tax that would otherwise have resulted from the 21-year deemed-disposition rule.
Subsection 104(4) of Canada’s Income Tax Act deems a trust to have disposed of all its capital property at fair market value every 21 years. This deemed disposition causes the trust to realize capital-gains tax every 21 years. Knowledgeable Canadian tax-planning lawyers have devised several tax-planning strategies to avoid or defer the trust’s capital-gains tax resulting from the 21-year deeming rule. (For more information on tax reporting for trusts, read our article on the trust tax-reporting rules for the 2023 taxation year.)
One tax strategy is for the trust to distribute its assets (just before the 21 years expires) to its beneficiaries under the trust-specific tax-rollover rule under subsection 107(2) of Canada’s Income Tax Act. This trust-specific tax-rollover rule applies only if the beneficiary receiving the trust assets is a Canadian tax resident. If the trust distributes its assets to a non-resident beneficiary, it triggers a deemed disposition at fair market value, thereby triggering capital-gains tax for the trust.
This obviously posed a problem for the non-resident beneficiaries in the Preston case. To deal with this problem, their Canadian tax-planning lawyers implemented a tax reorganization whereby the non-resident beneficiaries became the sole shareholders of an Alberta unlimited liability company (ULC)—which, by virtue of being incorporated in Canada, is deemed to be a Canadian tax resident. The non-resident beneficiaries then assigned their capital interests in the trust to the Alberta ULC under the section 85 tax-deferred rollover. This meant that the Alberta ULC, a Canadian tax resident, was now the sole beneficiary of the Canadian trust, and that the trust distribution would now qualify for the trust-specific tax-rollover rule under subsection 107(2) of Canada’s Income Tax Act. The Canadian trust accordingly distributed its capital assets to the Alberta ULC and avoided the capital-gains tax resulting from the 21-year deeming rule.
After initiating a tax audit, the Canada Revenue Agency challenged the legitimacy of the tax reorganization. Specifically, the CRA tax auditor alleged that, despite the assignment, the Alberta ULC never assumed the role of the trust’s beneficiary, and that the two non-resident individuals had retained their status as the trust’s beneficiaries throughout. Therefore, according to the Canada Revenue Agency, the trust distributed its property to the non-resident individuals, not to the Canadian-resident ULC. The CRA subsequently assessed the trust for over $12 million in capital-gains tax.
After the Canada Revenue Agency’s Appeals Division rejected the taxpayers’ notice of objection, the taxpayers’ Canadian tax-litigation lawyer challenged the CRA’s $12 million tax assessment by filing a notice of appeal to the Tax Court of Canada.
The CRA Canadian tax-litigation lawyer responded by filing a reply to the notice of appeal. As required by the Tax Court’s procedural rules, Tax Court of Canada Rules (General Procedure), the CRA’s reply included a section listing the factual assumptions underlying the CRA tax auditor’s decision to reassess.
The list included the following five statements:
- “On September 25, 2014… the fair market value of the [property] received by Mr. and Mrs. Preston was $75,511,267, comprised of the [fair market value] of the Holdco shares of $67,979,759 and the [fair market value] of the Partnership interest of $7,531,508.”
- “At all material times, the [Trust’s] beneficiaries were Mr. Preston, Mr. Preston’s spouse (Ms. Preston), and Mr. Preston’s issue.”
- “The [Trust’s] beneficiaries could only be natural persons.”
- “The [Trust’s] beneficiaries could not be corporations.”
- “After the Assignment, Mr. and Ms. Preston remained the income and capital beneficiaries of the [Trust].”
- “ULC was not a beneficiary of the [Trust].”
The Canadian tax-litigation lawyer representing the taxpayers filed a motion with the Tax Court of Canada to strike these statements (i.e., delete them) from the CRA’s reply. During the motion hearing, the taxpayers’ Canadian tax-litigation lawyer argued that these statements weren’t factual assumptions but legal conclusions. The taxpayers’ tax lawyer contended that these legal conclusions failed to identify any factual allegations that could be proved or disproved, and for that reason, they “do not enable the [taxpayer] to know the case to be met.”
The Tax Court of Canada agreed, finding that all six statements consisted of legal conclusions. Not a single one, the court held, was a factual statement that the CRA could assume for the purposes of tax litigation.
In response, the Canada Revenue Agency’s Canadian tax-litigation lawyer challenged the Tax Court’s decision by filing an appeal with Canada’s Federal Court of Appeal.
Arguing before the Federal Court of Appeal, the CRA’s Canadian tax-litigation lawyer maintained that the Tax Court’s decision had run afoul of subsection 53(1) of the Tax Court of Canada Rules (General Procedure). This provision gives the Tax Court of Canada the discretion to strike out any portion of a party’s pleadings if those pleadings “may prejudice or delay the fair hearing of the appeal” or are “an abuse of the process of the [Tax] Court.” According to the CRA’s Canadian tax-litigation lawyer, the Tax Court contravened subsection 53(1) by rendering its decision without considering whether the CRA’s pleadings had “prejudiced or delayed” or had “abused” the proceedings.
Canada’s Federal Court of Appeal sided with the Canada Revenue Agency and overturned the Tax Court’s decision. The appellate court found that the Tax Court had erred by failing to consider or apply the test in subsection 53(1) of the Tax Court of Canada Rules (General Procedure). The Federal Court of Appeal also disagreed with the Tax Court’s conclusion that a statement of mixed fact and law cannot stand as one of the CRA’s factual assumptions. “There is no principle of law,” announced the appellate court, “that a statement of mixed fact and law cannot stand as an assumption.”
The appellate court also reasoned that the taxpayer suffered no prejudice as a result of the CRA’s defective pleadings because the parties demonstrated that they understood each other’s positions. According to the Federal Court of Appeal, a court need not strike the Canada Revenue Agency’s defective tax-litigation pleadings “if, for example, the facts are relatively simple, there is little or no debate about the applicable legal principles, or there is little risk that the [taxpayer] will be prejudiced or will be obligated to waste resources.” The Federal Court of Appeal clarified that, “before striking out a pleading [concerning the Canada Revenue Agency’s assumptions], the Tax Court must consider whether it is appropriate to do so in the circumstances having regard to […] whether there is risk of prejudice or delay in the fair hearing of the appeal if the assumption is permitted to stand.”
The Federal Court of Appeal allowed the Canada Revenue Agency’s appeal, overturned the Tax Court’s decision, and permitted the CRA’s tax-litigation pleadings to retain all the assumptions as they had originally appeared.
Canada v. Adboss, Ltd., 2023 FCA 201
About six weeks after rendering the Preston decision, the Federal Court of Appeal decided Canada v. Adboss, Ltd., 2023 FCA 201.
This case involved three corporate taxpayers whom the CRA’s tax auditors had reassessed for GST/HST. The Canada Revenue Agency’s tax auditors alleged that the taxpayers had rendered taxable supplies to Canadian tax residents, and that the taxpayers were therefore required to charge GST/HST for their services and remit that GST/HST to the CRA. The taxpayers disputed the GST/HST reassessments, arguing that the impugned services were zero-rated supplies because they were provided to non-residents of Canada.
The taxpayers’ Canadian tax-litigation lawyer ultimately filed notices of appeal to the Tax Court of Canada, and the Canada Revenue Agency’s Canadian tax-litigation lawyer filed a reply to each notice of appeal.
Each of the Canada Revenue Agency’s replies contained a paragraph listing the factual assumptions that the CRA made when reassessing the taxpayers. Notably, each reply listed the following as one of the CRA’s factual assumption:
“At all material times, the controlling mind and management of [the taxpayers’ customer] was in Canada.”
On two occasions, the taxpayers’ Canadian tax-litigation lawyer demanded that the Canada Revenue Agency provide particulars about this alleged assumption. The demands included questions such as:
- What did the CRA mean by “the controlling mind and management was in Canada”?
- Did any specific person exercise the “controlling mind and management” of this entity in Canada?
- If so, how and in what manner was this control exercised?
On both occasions, the CRA refused to provide any information.
As a result, the taxpayers’ Canadian tax-litigation lawyer filed a motion asking the Tax Court of Canada to delete the following statement from the CRA’s tax-litigation pleadings: “At all material times, the controlling mind and management of [the taxpayers’ customer] was in Canada.”
The taxpayers’ motion invoked subsection 53(1) of the Tax Court of Canada Rules (General Procedure), which, as mentioned above, gives the Tax Court of Canada the discretion to strike out any portion of a party’s pleadings if those pleadings “may prejudice or delay the fair hearing of the appeal” or are “an abuse of the process of the [Tax] Court.”
Appearing before the Tax Court of Canada, the taxpayers’ Canadian tax-litigation lawyer contended that the impugned statement was indeed not a factual statement or factual assumption; it was rather a statement of mixed fact and law. In other words, it was a legal conclusion: it purported that a set of facts had satisfied a particular legal test. A legal conclusion doesn’t belong in the factual-assumption section of the Canada Revenue Agency’s tax-litigation pleadings. These pleadings, argued the taxpayers’ Canadian tax-litigation lawyer, should instead have extricated the factual assumptions that led the CRA to conclude that “the controlling mind and management of [the taxpayers’ customer] was in Canada.”
The Canada Revenue Agency’s Canadian tax-litigation lawyer responded by arguing that, although the CRA certainly couldn’t assume that the customer was “a [tax] resident of Canada,” the CRA could assume that the customer’s “controlling mind and management was in Canada.” According to the CRA’s Canadian tax-litigation lawyer, this statement was still a factual statement—even though the mind-and-management test is the legal test for determining corporate tax residency. The CRA’s Canadian tax-litigation lawyer also claimed that, even if the mind-and-management statement was a legal conclusion, the CRA’s pleadings had already extracted the factual components of that conclusion and listed them in the preceding paragraphs.
The Tax Court sided with the taxpayer. The court rejected the CRA’s claim that this statement was a factual statement. The legal test for corporate tax residency depends on the location of the corporation’s “controlling mind and management.” Courts must consider various facts to make that determination, but the conclusion of that determination is not itself a factual statement; it’s a legal conclusion. The Tax Court also noted that the Supreme Court of Canada had previously indicated that the location of a corporation’s controlling mind and management is a question of mixed fact and law, so the Canada Revenue Agency couldn’t plead the mind-and-management statement as a factual assumption. The court concluded that subsection 53(1) of the Rules permitted the court to delete this alleged assumption from the CRA’s pleadings.
Hence, because the [taxpayer] will have to speculate as to the facts underlying the conclusion of mixed fact and law of the [Canada Revenue Agency] that the “controlling mind and management” of [the customer] was in Canada, and because the [taxpayer] therefore cannot be properly prepared for and proceed with discoveries, this will prejudice or delay the fair prosecution of the appeal and constitutes an abuse of the Court’s process.
The Tax Court therefore allowed the taxpayers’ motion and deleted from the CRA’s pleadings the statement that “the controlling mind and management of [the taxpayers’ customer] was in Canada.”
The Canada Revenue Agency’s Canadian tax-litigation lawyer appealed the decision to Canada’s Federal Court of Appeal, but the CRA fared no better there. The Federal Court of Appeal upheld the Tax Court’s decision, agreeing with the Tax Court’s finding that the mind-and-management statement in the CRA’s pleadings was a legal conclusion, not a factual assumption.
The Federal Court of Appeal rejected the CRA’s claim that the Tax Court had erred when concluding that the impugned pleadings prejudiced the taxpayers and constituted an abuse of process. When coming to this conclusion, the appellate court highlighted the CRA’s repeated refusal to provide the taxpayers with particulars:
The [Canada Revenue Agency] refused to respond to the demands for particulars. [The CRA’s Canadian tax-litigation lawyer] only informed the [taxpayers] that no additional facts underlined the Impugned Assumption at the hearing before the Tax Court. If the [the CRA’s Canadian tax-litigation lawyer] had simply answered the demands for particulars, a motion to strike would have been unnecessary. In such a scenario, the deficient pleadings in the replies would have been fixed. [para 21].
Not only did the [CRA’s Canadian tax-litigation lawyer] refuse to provide particulars, he refused to do so in respect of an element of his pleadings that went to the heart of the appeal—namely, whether the [customer’s] controlling mind and management is in Canada. The answer to that question will dictate whether GST/HST should have been collected. The [taxpayers] had few options if they wanted to know what factual assumptions they must demolish in order to succeed in their appeal. Bringing the motion to strike was one of those options. It entailed unwarranted costs and time, and delayed the hearing of the appeal. [para 22].
Before dismissing the CRA’s case, the Federal Court of Appeal made it clear that its decision doesn’t mean that courts should automatically strike all assumptions of mixed fact and law. The appellate court explained that the CRA may plead legal conclusions as factual assumptions if (1) those conclusions are tangential—that is, they don’t go to the heart of the tax litigation itself—and (2) those conclusions don’t leave the taxpayer to speculate exactly which fact or facts the Canada Revenue Agency had assumed.
In this case, however, the CRA’s pleadings failed to meet either of these two conditions. First, the location of the customer’s controlling mind went to the heart of the tax dispute itself: it determined whether or not the taxpayers were obligation to charge and remit GST/HST. Second, the taxpayers couldn’t clearly discern the underlying facts because the “test for controlling mind and management is complex and shaped by decades of jurisprudence; a plethora of facts may inform the conclusion that the [customer’s] controlling mind and management was in Canada.” [para 24].
Case Comment: Reconciling Preston and Adboss
In Canadian tax litigation, the taxpayer generally bears the burden of disproving the Canada Revenue Agency’s factual assumptions. The procedural rules of tax litigation require the CRA’s pleadings to state the factual assumptions, but in practice, the CRA’s tax-litigation pleadings often mistakenly list legal conclusions as “assumptions of fact.” The Federal Court of Appeal’s Preston decision suggests that the CRA can get away with these defective pleadings, but the court’s Adboss decision suggests perhaps not.
Although the Federal Court of Appeal’s Preston and Adboss decisions seem contradictory at first glance, a careful analysis shows that they’re indeed consistent. The consistency revolves around the principle that the CRA may plead a legal conclusion as a factual assumption if that legal conclusion (1) doesn’t speak to the very legal issue at stake in the tax litigation and (2) doesn’t leave the taxpayer to speculate exactly which fact or facts the Canada Revenue Agency had assumed.
In the Adboss case, the CRA’s tax-litigation pleadings violated both of these conditions. First, the CRA’s pleadings adopted, as a factual assumption, the legal conclusion that “the controlling mind and management of [the taxpayers’ customer] was in Canada.” The mind-and-management test determines whether a corporation is a Canadian tax resident, which was the central legal issue in the Adboss case: the taxpayer was obligated to collect and remit GST/HST if and only if the taxpayer’s customer was a Canadian tax resident. Hence, by listing the mind-and-management statement as a factual assumption, the CRA’s tax-litigation pleadings had essentially presupposed correctness of the CRA’s own legal position, which was the very thing at issue in the dispute. Moreover, the mind-and-management test calls for a nuanced, contextual analysis. A number of factors, considered holistically, determine the location of a corporation’s controlling mind and management. Thus, the mind-and-management statement in the CRA’s tax-litigation pleadings left the taxpayer completely in the dark about which factual assumptions could’ve led to that legal conclusion.
By contrast, in Preston, the Canada Revenue Agency’s defective factual assumptions neither presupposed the correctness of the CRA’s legal position nor left the taxpayer in the dark about the facts that the CRA had assumed. The first defective pleading was a statement about the “fair market value” of various assets, and the remaining defective pleadings were statements about who were or weren’t the beneficiaries of a trust. While “fair market value” is ultimately a legal term of art in tax jurisprudence, this wasn’t the main legal issue in dispute, and it wasn’t difficult to discern that the underlying factual assumption related to valuation. Likewise, a person’s status as a trust beneficiary is a legal determination, but in Preston, the taxpayers could readily make out that the underlying factual assumptions related to the improper execution of legal documents.
Also, in Adboss, the CRA’s Canadian tax-litigation lawyer further prejudiced the taxpayers by refusing to provide the particulars that would have shed light on the Canada Revenue Agency’s factual assumption.
Pro Tax Tips & Expert Canadian Tax-Litigation Lawyer Tax Guidance: When Is it Worth Challenging the CRA’s Defective Tax-Litigation Pleadings?
The Federal Court of Appeal’s Preston and Adboss decisions demonstrate that during tax litigation, Canadian taxpayers must pick their battles. Not every defective pleading is worth challenging. If the Canada Revenue Agency’s tax-litigation pleadings contain errors or defects, taxpayers should carefully decide, with input from an experienced Canadian tax-litigation lawyer, whether there’s anything to be gained from challenging the defect and whether challenging the defect is even worth the legal costs to do so. As the court articulated in Adboss, the Canada Revenue Agency can get away with pleading a legal conclusion as a factual assumption if the legal conclusion doesn’t speak to the very legal issue at stake in the tax litigation, and the legal conclusion doesn’t leave the taxpayer to speculate exactly which fact or facts the Canada Revenue Agency had assumed.
As a practical matter, however, Canadian taxpayers will often find themselves incapable of determining whether the CRA’s tax-litigation pleadings violate these conditions. The good news is that Canadian taxpayers can avoid these problems through early engagement of an experienced Canadian tax-litigation lawyer. While the CRA’s tax lawyers at the Department of Justice may employ pre-trial tactics aimed at undercutting your case, a skilled CRA tax lawyer in Toronto can determine whether the CRA’s tax-litigation pleadings have incorrectly classified legal arguments as factual assumptions. Our seasoned Canadian tax lawyers possess an in-depth understanding of the intricacies of tax litigation. We can guarantee that your appeal to the Tax Court of Canada will be forceful, comprehensive, and cogent.
Frequently Asked Questions
I understand that, in Canadian tax litigation, the onus is initially on me to disprove the factual assumptions made by the Canada Revenue Agency. How can I identify these factual assumptions?
In a Tax Court appeal, the CRA’s factual assumptions will be evident in the CRA’s pleadings, known as the Reply. Procedural rules in tax litigation mandate that the CRA’s pleadings specify the factual assumptions that the Canada Revenue Agency tax auditor made “when making the assessment.” This requirement ensures that the taxpayer’s Canadian tax-litigation lawyer precisely knows which factual assumptions to disprove. Yet, in practice, the CRA’s tax-litigation pleadings often mistakenly label legal conclusions and statements of mixed fact and law as “assumptions of fact.” Distinguishing between genuine factual assumptions requiring disproof and legal conclusions can be challenging. Fortunately, this issue can typically be addressed through early engagement with an experienced Canadian tax-litigation lawyer, who can assess whether the CRA’s tax-litigation pleadings inaccurately classify legal arguments as factual assumptions.
DISCLAIMER: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.
Disclaimer:
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."
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