Jan 26th, 2023
Dec 16th, 2016
By Barry Landy
The cartoon character, Wimpy, loved hamburgers. He was also a hustler. He would gladly make you a promise to pay tomorrow, for an immediate benefit today.
I was thinking about that while considering the following question: Can you make an agreement with the Minister of National Revenue to the effect that a reporting position taken by a taxpayer in a current year will be accepted, if the taxpayer refrains from engaging in similar transactions in future years?
That was the question put to the Federal Court in the case of Rosenberg v. MNR (2016 FC 1376).
The taxpayer had engaged in certain “straddling transactions” in 2006 and 2007, that is, a series of transactions that involved taking business losses in one year and turning the sale of partnerships into capital gains the year after. Because the inclusion of business losses (100% of losses) and capital gains (50% of capital gains are taxable) is different, the taxpayer is advantaged.
In February 2010, the taxpayer made what he said was an agreement with CRA following an audit of his 2006 and 2007 taxation years. The agreement set out that considering the “legal uncertainties”, CRA would not assess those years, provided, essentially, that the taxpayer “would never do it again”.
In January 2013, a new auditor for the CRA sent the taxpayer a demand for information for the 2006 and 2007 taxation years, directly in relation to the straddle loss issue, and the taxpayer responded by refusing to provide the information and alleging that the February 2010 agreement was a complete bar to the Minister re-auditing and re-assessing his 2006 and 2007 years. There was no suggestion made that the taxpayer had violated the agreement. There was no suggestion made that the CRA representative who made the agreement did not have the authority to do so.
Nevertheless, the agreement was somewhat unusual. The Minister took the position that an agreement not to audit amounted to an agreement to forego administering and enforcing the Income Tax Act (“ITA”) but the Federal Court disagreed, saying that while the Minister had the duty to enforce the ITA, it was up to the Minister to decide how to use those powers and that reaching an agreement with a taxpayer was a perfectly legitimate means of administration and enforcement.
The Minister then tried to argue that the whole agreement was invalid because the Minister could not legally agree not to assess a taxpayer for an amount owed. The Minister pleaded that if the facts are known and the law is understood, the Minister cannot make an agreement that will call for payment of an amount less than what the law says is owed.
This argument, the so-called “principled settlement” rule, failed.
After citing the Galway (Galway v. MNR  1 FC 600) and Cohen (Cohen v. R. (1980) 80 DTC 6250) cases, which stand for the principle that agreements whereby the Minister would agree to assess income tax otherwise than in accordance with the law would be illegal agreements, and hence unenforceable, the Federal Court went on to considerably narrow the scope of these cases, saying that the Minister can always agree to assess, based on the facts as known and the law as understood.
In other words, consider the case of the real estate developer who buys and holds land allegedly as capital property and not inventory. The developer sells the land and declares a capital gain for tax purposes. As part of a negotiated settlement, the taxpayer and the Minister cannot agree, for example, that because on the facts there is a 50/50 chance that the taxpayer’s filing position will ultimately be successful, the case could be settled based on, let’s say, ½ the tax otherwise owing, to take into account litigation risk. A settlement in a case like this must be an “all or nothing” proposition. Either the Minister is right, on the facts, whereupon the tax consequences inexorably follow, or the Minister is wrong on the facts, whereupon the taxpayer must win.
In the Rosenberg case, one might have thought that the situation was quite similar. The facts and circumstances of the straddle either ought to have given rise to tax, or not, just like in the hypothetical case of the real estate developer claiming a capital gain on a land sale: Either the facts support capital gains treatment, or they do not. Either the facts justified the straddle plan or they did not.
However, in Rosenberg, the Federal Court found that unless there was specific authority to prevent agreements between the Minister and a taxpayer, such agreements should be upheld. It was up to the Minister to decide what he had to do to make a proper assessment ascertaining and fixing the liability of the taxpayer, including the extent of any investigation that he wanted to make, if any.
To the argument of the Minister that no agreement between the Minister and a taxpayer can interfere with the Minister’s right to conduct an audit, the Court replied that entering contracts stating that a taxpayer will not be audited for a specific taxation year in relation to a specific transaction is perfectly valid and not incompatible with the Minister’s right to reassess, unless the taxpayer reneged on the agreement, for example, in the Rosenberg case, by engaging in straddle transactions after 2007. The Court held that the goal of the agreement was certainty, which was a legitimate objective to pursue for both the taxpayer and the Minister.
In short, while it is true that settlements between taxpayers and the CRA have to be “principled”, the definition of what is or is not principled appears to be getting narrower.
Moreover the Rosenberg case seems to be an interesting precedent to argue that in the context of settlement negotiations, the taxpayer should try to obtain a “no further audit” agreement, for settled years.