Copyright 2011, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax Controversy & Litigation, January 2011
Over the last few years, there has been an increase in the number of procedural disputes making their way through Canadian courts as part of the tax resolution process. The amount of money at stake and the complexity of the issues and facts in transfer pricing and tax avoidance cases are clearly factors which have sparked such disputes. There is no doubt that both taxpayers and government have been taking a "bet the company" approach during the tax audit of such issues and this desire and need to win has spilled over into the court process. Consequently, in 2010, in response to court motions, Canadian tax courts rendered multiple decisions about such issues as the expiry of limitation periods, the adequacy of court pleadings, the inadequacy of responses provided at examinations for discovery, the legality of government subpoenas or demands for documentation, the burden of proof and the admissibility of evidence, including expert evidence.
Taxpayers defending tax disputes now need to recognize that the prospect of "trench warfare" in tax court proceedings will create a more costly dispute process, could hamper settlement discussions and will lengthen the time period within which the tax dispute will ultimately be adjudicated on its merits. These developments obviously will not sit well with taxpayers who want a speedy resolution of the merits of the substantive issues and who do not view the tax litigation process as a value-added exercise. Nonetheless, taxpayers must recognize that these so‑called procedural disputes have regrettably become part of the fabric of large-case dispute resolution where each side is looking to acquire a tactical advantage. Ideally, taxpayers will wish to conduct their tax dispute resolution with the least amount of dislocation and cost. Yet, if the Crown decides to adopt an aggressive litigation posture, taxpayers are faced with having to respond in kind in order to safeguard positions.
Attitude of the Courts
How do judges tend to view the thrust and parry of the tax litigation process and the increasing number of motions to expunge offensive material from pleadings or to compel responses or documentation from nominees on discovery? Some judges have not hidden their feelings about these changing dynamics in the tax litigation process. Most recently, on December 30, 2010, Chief Justice Rip of the Tax Court of Canada rendered a decision in Cameco Corporation v. The Queen on a motion of the taxpayer to strike a portion of the Crown's pleadings and a motion by the Crown to strike an affidavit filed by the taxpayer. The case involves a transfer pricing dispute under section 247 of the Canadian Income Tax Act. The Canada Revenue Agency (the CRA) challenged the terms of the transfer pricing arrangement on one basis during the audit process. However, when pleadings were filed by the Crown in Tax Court, new arguments or different bases of assessment were raised including "recharacterization", "sham", and "indirect transfers of income". The taxpayer was obviously angered by the desire of the Crown to raise new theories to further justify the reassessments. What added insult to injury is the prospect of the Crown using the Tax Court process to go on a "fishing expedition" to gather evidence to prove facts needed to support these new theories. The taxpayer was further angered by the refusal of the Crown to provide particulars of new theories raised in its pleadings.
In his reasons, the Chief Justice denied the Crown's motion to strike and, contrary to the taxpayer's request, struck out only nine of 19 paragraphs in the Crown's pleadings. The Chief Justice awarded costs to neither party. However, all taxpayers, the Crown and both parties' counsel should heed the pointed remarks made by the Chief Justice in paragraphs 37 and 38 of his reasons in Cameco (footnotes omitted):
" Neither counsel, it seems to me, has displayed any great effort to grease the wheel that operates the appeal process. The respondent's reply contains assumptions that lack many material facts. Respondent counsel's reply that one would have to await discovery for answers was glib, inviting action from the other side. On the other hand, the appellant had indicated it would prepare an answer to the reply and the respondent granted extensions to the appellant to file an answer. That the appellant's counsel informed opposing counsel that it was anticipating filing an answer to the reply would suggest to most reasonable people that the appellant was not planning to attack any provision of the reply notwithstanding that there may be irregularities in the reply. The parties had also agreed to exchange documents in accordance with section 82 of the Rules. In the meantime counsel for the appellant, keeping things close to their vests and not informing colleagues on the other side, were preparing to serve a demand for particulars which, as respondent's counsel stated, if the information were not provided, would be met with a motion to strike portions of the reply.
 My impression from hearing these applications is that both parties are using tactics that will end up in some sort of skirmishing that, as Bowman C.J. observed in Sackman v. The Queen and Satin Finish Hardwood Flooring (Ontario) Limited v. The Queen would see this Court turned into a forum for procedural manoeuvring and lawyer upmanship. Appeals are taking longer and longer and counsel have a responsibility to not only use but also exploit their skills and talent to ensure that procedures leading to the hearing of the appeal, as well as the hearing itself, are done efficiently and with mutual respect of counsel."
Guidance for Taxpayers
This admonition from the Tax Court must obviously be heeded. At the same time, taxpayers have the right to challenge alternate bases of assessment raised by the Crown. When the Crown does so, then fearless advocacy may be the only appropriate response available to taxpayers to safeguard their rights and substantive positions. As a bigger picture point, however, taxpayers must recognize that this course of conduct by the Crown is becoming more routine. New theories are being raised in transfer pricing and tax avoidance cases to combat "aggressive" tax planning in order to justify or bootstrap earlier audit work. The ongoing litigation in the Tax Court involving HSBC Bank Canada and the deductibility of guarantee fees reflects the same course of conduct. Overall, taxpayers must recognize that the Crown wants to win and will contest the positions taken by taxpayers with all procedural weapons available to it both before and during the Tax Court process.
Taxpayers undertaking what the CRA refers to as "aggressive tax planning" should therefore budget appropriate resources, including the availability of personnel, to assist in the document management and retrieval process. Taxpayers should also expect to be patient as a lengthy audit and ultimately prolonged litigation process unfolds. What seems quite apparent is that tax planning once considered acceptable to the authorities has now become labelled as "aggressive".
Therefore, taxpayers must be mentally and financially prepared for the types of struggles now wending their way through the tax audit and Tax Court process. It would be highly unfortunate for taxpayers with meritorious positions on the substantive issues to have to compromise or fold in a tax dispute because of the consequential fatigue and associated costs occasioned by procedural fights. Corporate tax directors may find they will not be given the resources to effectively fight the dispute at hand if management sees a more productive use of corporate resources than for a prolonged tax dispute initiated or precipitated before the appointment of current management.
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