A note on the burden of proof in tax cases.
Taxpayers are often surprised to learn that in appeals to the Tax Court of Canada, the rules are not the same as in other Canadian courts and are not what you would expect in litigation with the government of Canada. When a taxpayer disputes an assessment of tax in Court, it is an appeal from the assessment. The assessment is deemed to be correct until the taxpayer shows that it is wrong. In addition to this burden, the facts the auditor and appeals officer assumed in assessing a taxpayer are presumed by the Court to be true until a taxpayer demolishes them by showing that they were not made by the auditor or appeals officer, that they are not true or that they do not result in the tax assessed.
1ABIL claim disallowed.
The taxpayer had advanced significant sums of money to his spouse’s corporation, whose business was failing. He was advised to forgive the debt to attract additional investment. He did so. Unfortunately, the improved balance sheet did not attract enough interest to sustain the corporation. The Minister disallowed the taxpayer’s allowable business investment loss claim as there was no debt outstanding at the end of the year as required by the Income Tax Act. This was of course true as the debt had been forgiven. In reporting his income, the taxpayer had carried back his loss resulting from the allowable business investment claim to prior years’ income. As a result, there were many years before the Tax Court. In a settlement conference, we were successful in persuading the Minister to accept that the loss was equally available on the evidence and the particular financial conditions of the corporation in a prior year, i.e. a year before the loan had been forgiven and we successfully resolved the appeal on that basis.
2ABIL claim generates refund to pay tax arrears.
The taxpayer had advanced his heart, soul and all of the over $2 million in equity in his home into his wholly owned business which fell significantly behind on its payroll liabilities. He had been assessed as a director liable for the amounts the corporation had failed to remit, penalties and accrued interest. We suggested that on the particular facts of his case, an allowable business investment loss may be available. The Minister agreed and when the losses arising from that claim were applied to his prior profitable years’ personal income tax returns, his income tax refunds were more or less equal to the full amount of tax, interest and penalty assessed to him as a director.
3Voluntary disclosure for deceased husband who had abandoned his widow and children.
When her husband passed away a widow discovered that not only had her late husband excluded her and her children from his will, he had kept income-producing assets outside of Canada that had not been reported to the Minister. Estate litigation commenced and in her settlement, she became entitled only to those offshore assets and was appointed trustee of her late husband’s estate. We initiated a voluntary disclosure for the estate and asked the Minister to only assess the last three years of income earned in the offshore accounts as any more would deprive the widow and her children of their only assets after long, arduous and expensive litigation. The Minister agreed.
In two unrelated cases, the taxpayers’ bookkeepers had understated the business’ payroll liabilities. One had been discovered by the Minister before the taxpayer. The other learned of the bookkeeper’s actions in the course of an audit. For the first, we were able to persuade the Minister that the taxpayer’s conduct was sufficiently and duly diligent to result in the cancellation of all penalties assessed; had management known of the improprieties, different business decisions would have been made. For the second, we were able to persuade the Minister that no penalties ought to be assessed in light of the extraordinary conduct of the bookkeeper, which could not have been foreseen by the taxpayer.
5Condo flipping project.
We have represented many taxpayers caught in the Minister’s condo flipping project. Most have been reversed in their entirety following our submissions, including:
- A real estate agent who had purchased a condominium for his mother who was later unable to immigrate to Canada in light of her familial obligations abroad;
- A young professional whose career path changed dramatically from the time he purchased the unit to the closing date; and
- Parents who bought condos for their children but changed their minds.
In each of these cases, the length of time between the signing of the agreement of purchase and sale and the closing of the property was significant, but the period of legal ownership was quite short.
6Criminal charges for failing to file tax returns.
In two unrelated cases, the taxpayers had been charged for failing to file income tax returns as demanded by the Minister. The first taxpayer was a Canadian music icon. The second, a small business owner. In both cases, the charges were withdrawn by the Crown prior to trial. For the musician, it was not clear that the culpability for the failure to file was the taxpayer’s, his agent’s or his accountant's. In light of the uncertainty and the correspondence prior to the summons being served, the Crown agreed to withdraw all charges. For the small business owner, deficiencies in the charging document itself were sufficient to have the Crown revisit the propriety of the charges to begin with.
7Deemed capital gains.
The taxpayers, who were husband and wife, had made a generous gift of their Canadian real properties to their children. The Income Tax Act deems dispositions of property to related parties, even where they are gifts, to occur at fair market value. In calculating the deemed capital gain on their gifts, the taxpayers used the municipal assessed values. The Minister disagreed and revalued all the properties and increased the capital gain assessed by more than 27 per cent. At the Tax Court of Canada we asked the Minister to consider that the definition of principal residence includes residences occupied by children and on that definition the gain assessed in respect of one of the properties had been too high. The appeal settled.
The Minister assessed our client for additional income and notional withholding taxes on amounts the Minister said should have been taxed as profits in Canada. After reviewing the auditor’s extensive work, we were able to establish that the auditor had misunderstood the function of a currency devaluation premium provided for in the taxpayer’s contemporaneous documentation and its application in all the years in issue in light of the actual currency exchange rate fluctuations in the year. We were able to work with counsel abroad and assemble sufficient evidence of these valuations, the raw material costs and the impact of currency fluctuation on prices to persuade the Minister to reverse the assessments in their entirety.
9$18 million loss disallowed fourteen years later.
The taxpayer had claimed losses for more than eight consecutive years. In the course of auditing a five-year old return for the eighth consecutive year, the Minister audited the loss-carryforward balances and wanted all the supporting documents relating to the original loss reported of $18 million. The accounting firm who had audited the return was no longer in existence and the records substantiating the original loss had been destroyed in accordance with the firm’s practice. On reviewing the records maintained by the Minister for the taxpayer, we learned that the corporation’s return for the year of the original loss had been reviewed by the Minister and that the Minister had reviewed the loss balance reported. The auditor was not persuaded that he had the authority to rely on the Minister’s prior findings and reassessed the corporation to disallow the $18 million loss. The interest alone was over $900,000. We objected and ultimately persuaded the appeals officer that no adjustment ought to have been made to the original loss reported. The disallowance of the $18 million loss was reversed.
10Penalty assessed for failing to report T4 income.
The taxpayer was a successful executive who had worked at different locations across Canada over a period of several years. She did not receive a T4 from one of her prior employers and unintentionally omitted the amount from her income tax return. The Minister assessed a punitive penalty on the amount and cited a previous nominal omission as grounds for imposing a repeat offender penalty. The taxpayer’s objection was unsuccessful. We appealed to the Tax Court of Canada. We learned that the documents produced in support of the Minister’s assessment had been reproduced from the Minister’s electronic record and that the original document had shown a different address. The Minister was not persuaded to delete the penalty. We learned that the prior nominal omission mistakenly showed income earned in a year other than the year in which the T4 was issued, taking the omission outside of the relevant section of the Income Tax Act permitting the punitive penalty. The Minister was still not persuaded to delete the penalty. We established, by obtaining and producing the employer’s records, that the taxpayer’s contact information had been updated in some internal records, but not in the payroll service provider’s records. On the eve of trial, the Minister accepted that the penalty was out of proportion to the taxpayer’s conduct and conceded the appeal.
11Capital or income? The recharacterization of sale proceeds.
The taxpayer had been reassessed to recharacterize the sale of certain substantial property as a sale on income account and not the capital gain it had been reported as. The result was a doubling of the taxes due. The taxpayer had argued that the property had been purchased not to sell but to hold, but the Minister determined that the prospect of selling the property was one of the reasons for its purchase and rejected the taxpayer’s submissions to the contrary. We appealed to the Tax Court of Canada. We reviewed the taxpayer’s business history and compiled a detailed record of the taxpayer’s historical long-term holdings. We reviewed the Minister’s file on the taxpayer and found that the Minister had determined that there had been a change of use in the property in the prior year, meaning that any gain in the year was nominal, as the value of the property had not changed significantly between the two years. We produced these detailed records of the taxpayer’s history and the Minister’s prior conclusions in the taxpayer’s list of documents. As we were scheduling the parties’ discovery examinations, the Minister conceded the appeal.
12Assessed proceeds of crime: In the wrong place at the wrong time.
The taxpayer had been sleeping on a friend’s couch and was awoken by a police raid. The police seized a significant yield of marijuana from a grow op in the locked basement. The taxpayer was the only person on the premises at the time of the raid. Although the narcotics charges against the taxpayer were withdrawn, the police sent the Minister a valuation of the seized plants and the Minister assessed the taxpayer as though he were entitled to the income from the sale of the plants. The taxpayer did not have very good records of the income he earned from the jobs he could get in the year. We appealed to the Tax Court of Canada. The Minister’s assessment was based, in part, on the belief that the taxpayer had a lifestyle that included support payments to his child, car payments, payments for recreation and donations, insurance, dentistry, optometry and other usual expenses. The taxpayer, while not proud of it, could not afford to pay and did not pay any of these expenses in the year assessed. On appeal, the Minister agreed that the assessment was out of all proportion to his lifestyle, agreed to an Order allowing the appeal, reducing the assessment by over 75 per cent and deleting the punitive penalties that had been assessed.
13Collection of twenty year old taxes.
The taxpayer had inherited her husband’s businesses and properties on his death. She maintained all the accounting and tax records back forty years. Twenty years before, her husband had unintentionally caused one of the corporations to file an excessive capital dividend election. When the corporation was reassessed, he had hired a respected accounting firm to dispute the assessment and the firm had taken a number of steps to rectify the problem. A corrective assessment was issued, but the problem was not rectified in the corporation’s returns for later years and another assessment issued. The accounting firm subsequently disbanded and the husband passed away. For over twenty years, notices of the tax and the accruing interest were mailed out, but the increasing balance, with interest compounded daily, did not appear on the ordinary income tax assessments mailed to the taxpayer in accordance with the Minister’s practice for the particular kind of tax assessed. The Minister, unable to collect the tax, garnished the corporation’s account and registered liens against its property. The widow and her current accountant could get no response from the Minister to the problem. The Minister’s appeals division would not hear the taxpayer’s objection as it was so many years statute-barred. The Tax Court did not have the jurisdiction under the Income Tax Act to hear the dispute. With the assistance of excellent records, we were able to persuade the Minister that there was no mischief, that the problem had, in fact, been fixed twenty years prior and that, although the twenty years of records were not correct, they could be corrected, without tax consequence, by a notation in the current shareholder loan account. The Minister agreed, the assessment was deleted and the liens and garnishments were removed.
14Double taxation on legal fees.
The taxpayer, a lawyer, had had his license to practice law revoked by his governing body. He incurred legal expenses in excess of $200,000 to appeal the decision and was ultimately successful. The taxpayer had paid his legal fees by assigning his professional corporation’s legal aid revenues to the law firm who had successfully represented him. Only certain identified types of legal fees are deductible from income as an expense of an individual or as a current expense of a corporation. In this case, the professional corporation deducted the expense as a current expense. The Minister reviewed the arrangement, determined that the professional corporation was not entitled to deduct the expense of the litigation lawyers and further determined that the professional corporation had conferred a benefit on the taxpayer equal to the amount of the fees paid. This resulted in a double tax blow: the corporation had the amount added back to its income and the taxpayer had the amount added to his income a second time. The lawyer had decided to represent himself in his appeal to the Tax Court and had waived his right to discovery examination of the auditor who had assessed him. The taxpayer was unable to locate the invoices relating to the expense or records of the payments from legal aid, but believed they had previously been provided to the Minister. Shortly before trial we obtained records from legal aid confirming the amounts paid and persuaded the Minister that the expense was properly the professional corporation’s expense: the professional corporation could earn no business revenues without the lawyer’s license and all of the legal fees were paid to appeal the decision to revoke his license. The Minister allowed the appeal on this basis.
A note on the deductibility of legal fees in tax disputes.
Unlike other litigation fees paid by individuals, all legal fees paid on account of an appeal to a fiscal court in relation to an assessment of tax (the Tax Court, Ontario Superior Court or Court of Appeal, the Federal Court or Court of Appeal or Supreme Court of Canada) or fees that are paid in relation to representations made to the Canada Revenue Agency in an audit or objection may be deductible pursuant to the Income Tax Act, effectively reducing the actual costs of disputing an assessment by the individual’s marginal tax rate. For example, if the fees are $5,000 and the individual’s marginal rate is 45 per cent, the individual’s taxes will be reduced by $2,250 (or $2,250 will be refunded) when the individual’s income tax return for the year the fees are paid is filed.
15It has been hard enough: a voluntary disclosure.
The taxpayer had struggled with her tax matters after a member of her family was involved in an awful accident in which another person had died. In the years following, in the midst of criminal and civil trials, her husband passed away. She omitted some income on her returns for over eleven years. We made an anonymous voluntary disclosure on her behalf and submitted that the Minister ought to assess only the three most recent years, as her omission was not attributable to neglect, carelessness or willful default on an objectively reasonable assessment. The Minister agreed and assessed only three of the eleven years.
16Accounting nightmare: a prosecution.
The taxpayer, who had recently immigrated to Canada and spoke little English, had entrusted the preparation of his tax returns to his chartered accountant. The returns did not reflect the taxpayer’s income. The taxpayer was charged with evading income tax and GST and with making false statements in his returns. After several pre-hearing motions relating to admissible evidence and disclosure, the Minister was persuaded that there was no reasonable prospect of convicting the taxpayer based on the available record and withdrew all charges against the taxpayer.
17Interest relief for struggling parents.
The taxpayers, parents of six children, successfully disputed a tax assessment reducing the amount assessed by over 95 per cent. In the years following the dispute, they made as many payments as they could on account of the arrears, but were unable to pay off the remaining five per cent. The interest charges were so significant that any payments did not reduce the tax. We applied for interest relief on the basis of ability to pay and the Minister disallowed the application, finding that the family continued to buy equipment to earn revenues and pay their staff. On a second level review, the Minister upheld the decision to deny relief. In an application for judicial review of the decision to the Federal Court, we obtained evidence suggesting that the Minister had reviewed the Low Income Cut Off or “poverty line” for the years, but had not considered that the amount the family was left with after the payment of taxes was below this Low Income Cut Off. The Minister agreed to an Order allowing the application for judicial review and referring the matter back for reconsideration on the basis that the family lived below the poverty line after the Minister took the tax payments.
Our tax strategies and plans are unique to the taxpayers they serve. To speak with us about how we can help identify tax planning opportunities unique to you or your client, please call 416.590.2671.
Disclaimer. The information on this site is not intended as legal advice. You should contact a qualified lawyer regarding your individual problem or situation. Contacting us does not create a lawyer-client relationship.