The Canada Revenue Agency (CRA) is afforded considerable latitude in administering and enforcing the Income Tax Act (Act). This latitude is reflected in its power to determine the scope of tax audits and issue tax assessments.
Over the past year, there have been key developments, both jurisprudential and statutory, relating to the CRA's power to audit and assess.
First, the Supreme Court of Canada has issued two decisions which confirm that there is divided jurisdiction between the Federal Court and Tax Court of Canada in addressing issues relating to the audit process and the correctness of assessments. This will continue to create challenges for taxpayers where issues arising from one matter may need to be pursued and resolved in different courts.
Second, proposed amendments to the Act will, if implemented, expand the CRA's discretionary power in conducting audits and may result in taxpayers facing penalties for not complying with demands for information. It will be important for taxpayers to understand these developments and their potential impact on audits and assessments in the years to come.
Jurisdictional divide between the Tax Court and Federal Court
Under the Act, a taxpayer is afforded the right to object to an assessment and, if necessary, then commence an appeal to the Tax Court. However, the Tax Court's role in this context is limited to determining the validity and correctness of the assessment.
The Tax Court does not have jurisdiction to order the CRA to take or revoke actions, even where those actions relate to the process by which an assessment was raised, the exercise of discretion by the CRA or another government department in connection with the merits of an assessment, or the conduct of the CRA in deciding to assess.
Instead, the Federal Court alone has the jurisdiction to review whether the CRA has exercised its discretionary powers reasonably. This jurisdiction applies even if the exercise or non-exercise of the CRA's discretion has resulted in the issuance of an assessment.
As it relates to tax matters, the divided jurisdiction between these courts has caused confusion for taxpayers and attracted much debate over the years.
Recent court decisions confirm the jurisdictional divide
The Supreme Court had the opportunity to address this confusion in two recent decisions, Dow Chemical Canada ULC v. The King and Iris Technologies Inc v. A.G. of Canada. The effect of these decisions is to confirm the divided jurisdiction in ways that complicate a taxpayer's recourse to the courts where the exercise of the CRA's discretion is at issue.
In Dow Chemical, a majority of the Supreme Court held that the Federal Court had exclusive jurisdiction to review the discretionary decision of the CRA not to grant a downward transfer pricing adjustment requested by the taxpayer in connection with wider transfer pricing assessment dispute, even though that decision impacted the assessment. The Supreme Court also held that, if a discretionary decision of the CRA is found to be unreasonable, the Tax Court does not have the power to grant the appropriate remedy — namely, an order requiring the CRA to reconsider its decision.
In Iris Technologies, the taxpayer brought an application for judicial review in the Federal Court, claiming that it had been denied procedural fairness in the audit and assessment process. The taxpayer argued that the CRA did not give it sufficient time to respond to a proposal to assess. The taxpayer also argued that the assessment in question had ultimately been issued without a sufficient evidentiary basis and for an improper purpose.
The majority of the Supreme Court in Iris Technologies held that the taxpayer was not in fact challenging an exercise of discretion by the CRA but instead its claims amounted to a collateral attack on the assessment. The Supreme Court found that an appeal to the Tax Court was an appropriate remedy for these complaints as the Tax Court could "cure any evidentiary defects" in the appeal. Although the Supreme Court determined that the claim regarding the CRA's improper purpose could also be subject to judicial review before the Federal Court, the majority concluded on the facts that the claim should be struck because the taxpayer failed to allege any supporting facts.
These decisions sought to clarify the jurisdictional divide between the Tax Court and Federal Court, while affirming the continued existence of that divide.
The divide between courts can place an undue burden on taxpayers by requiring aspects of the same assessment to be challenged in separate courts.
In Iris Technologies, the majority of the Supreme Court held that the CRA's conduct in the audit and assessment process could be addressed through an appeal to the Tax Court because the requested remedy was to vacate the assessment. However, in Dow Chemical, the Court reached the conclusion that an appeal relating to upwards transfer pricing adjustments may only be decided in the Tax Court, but a challenge to the exercise of the CRA's discretion to permit a downwards pricing adjustment must be brought in the Federal Court, ostensibly because the Tax Court lacks jurisdiction to order an appropriate remedy.
This continued dichotomy is onerous for taxpayers who risk incurring unnecessary expense and facing delay in addressing jurisdictional challenges and, in a worst case, a finding that their challenge has been pursued in the wrong court. Taxpayers would be well-advised to engage counsel in fully exploring both avenues for recourse and the best strategy to address potential jurisdictional uncertainty, including whether it is appropriate to pursue parallel proceedings in both courts.
Statutory amendments to expand audit powers
Statutory amendments are on the horizon that have the potential to alter the balance of power between the CRA and taxpayers. In 2024, the federal government proposed material statutory changes to expand the CRA's powers to collect information during an audit and to exact penal consequences for non-compliance. There are three principal changes proposed to the CRA's powers that, if enacted, will impact how taxpayers approach audits moving forward.
First, theCRA will have the power to require that information be provided in an audit under oath or affirmation. Given the potential for the CRA or Crown to use such information at a later stage of the dispute, taxpayers will need to be diligent in ensuring that anyone being interviewed by the CRA has been adequately prepared and is properly represented by counsel to ensure that appropriate procedural safeguards are in place.
Under the second proposal, where the CRA successfully applies to a Federal Court judge for an order requiring a person to provide requested information, a harsh penalty can be imposed on the taxpayer. As proposed, the taxpayer would be liable to a mandatory penalty of 10% of the aggregate amount of tax payable by the taxpayer for each taxation year to which the order relates. This penalty would apply regardless of whether the information obtained by the CRA ultimately leads to a reassessment. The possibility of such a harsh and disproportionate penalty may have a chilling effect on taxpayers bringing legitimate challenges to requests for information by the CRA, even those relating to the scope of solicitor-client privilege.
Third, the draft legislation proposes to permit theCRA to issue a notice of non-compliance. Unlike a compliance order, a notice of non-compliance would not require the CRA to obtain a court order. Rather, the CRA would be able to issue such a notice if the CRA determines at any time that a taxpayer has not complied with a request for information. The draft legislation provides for a two-step review procedure: first, a review by the CRA and then a review by the Federal Court. However, the Federal Court judge will only be able to vacate the notice if the CRA's decision under the first review is found to be unreasonable.
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There are two consequences arising from a notice of non-compliance. The taxpayer would be liable for a penalty of $50 for each day that the notice is outstanding up to a maximum of $25,000. Further, the limitation period for reassessment is extended for the taxpayer or any person that does not deal at arm's length with the taxpayer between the time the non-compliance notice was sent and when it is complied with.
Implications for taxpayers going forward
Given the jurisdictional divide between the Tax Court and Federal Court confirmed in the recent decisions, it is likely that taxpayers will continue to face challenges in obtaining appropriate relief.
Separately, the fact that the CRA would be authorized to issue a non-compliance notice, as well as the risk of an associated penalty, could provide an incentive to the CRA to issue overly broad and potentially unreasonable demands, thereby discouraging taxpayers from legitimately challenging those demands in court. In that regard,if the statutory proposals are enacted, it will be even more crucial for taxpayers to develop good working relationships with the CRA to ensure that requests for information are appropriately framed and that compliance is possible.
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