Introduction – The Settlement System and Tax Litigation
The Canadian legal system encourages legal disputes to be resolved by settlements rather than litigation to provide for relatively speedy and cost-effective resolutions to legal disputes. Various procedural mechanisms have been set up in our legal system to encourage settlements. Reaching a settlement also allows the parties involved in a legal dispute to save costs and avoid uncertainties in outcomes that always arise from litigation.
In areas of law such as tort law, contract disputes or family law, disputing parties can sometimes come to creative and flexible settlement solutions to achieve the goals of both parties; However, in the context of tax litigations, the jurisprudence based on subsection 220(1) of the Income Tax Act known as "principled settlement" significantly constraints the scope of what can be reached as an enforceable tax settlement between Canadian taxpayers and the CRA.
What is Principled Settlement
The Principled Settlement, stated briefly, is the rule that there must be a legal basis for a tax settlement reached between a taxpayer and the CRA in order for this settlement to be legally enforceable.
What makes tax disputes subject to the principled settlement rule is that the result of any tax dispute only determines whether an assessment or reassessment made by the CRA should be upheld or not. If a tax dispute concludes that the original CRA assessment or reassessment cannot be upheld, then CRA must reassess the taxpayer in accordance with the resolution of the tax dispute. Furthermore, unlike a contractual agreement between two private individuals where nearly any amount can be agreed upon between the parties, any assessment and reassessment issued by the CRA must be based on the provisions in Income Tax Act or Excise Tax Act.
This means that any CRA tax reassessment following the conclusion of a tax dispute between a taxpayer and the CRA must be bound by the same rule as any tax assessment or reassessment made against any Canadian taxpayer. That rule is laid out in subsection 220(1) of the Income Tax Act as:
220(1) The Minister shall administer and enforce this Act, and the Commissioner of Revenue may exercise all the powers and perform the duties of the Minister under this Act.
The Case Law on Principled Settlement
As a result, if a CRA reassessment following a tax settlement violates subsection 220(1), then such reassessments cannot be made by the CRA and effectively making the settlement unenforceable. The Federal Court of Appeals in Galway v. Minister of National Revenue encountered this issue when the CRA and the taxpayer reached a settlement of $100,000.00 in tax liability when the taxpayer was assessed initially over the failure to include a payment of $200,500.00 in his business income. The dispute was over whether all or none of the payment had to be included in the taxpayer's income, and neither total inclusion nor total exclusion could result in an increase of the taxpayer's liability by exactly $100,000.00, even factoring in partial or complete forgiveness of interest and penalties. Furthermore, there was no legal basis for only partial inclusion of the $200,500.00 payment.
In Galway, the Court rejected the $100,000.00 settlement as not having any basis in the Income Tax Act. In doing so, the Court considered and rejected three possible statutory grounds as to how the CRA could legally reassess the taxpayer for only $100,000.00 in increased tax liability. The Galway ruling means that the CRA cannot reassess a taxpayer on the basis of a compromise settlement if such reassessment cannot be justified as a reasonable interpretation of the Income Tax Act.
In Cohen v the Queen, the principled settlement rule was further clarified to mean an unprincipled settlement is an illegal one and that the CRA is not bound by the settlement to reassess the taxpayer in such a case.
Since the principled settlement rule only affects the CRA's ability to reassess in accordance with the terms of a compromise settlement, other elements of a tax settlement unrelated to subsection 220(1) could still be enforceable even when the settlement is "unprincipled."
Implication on Waiver of the Right to Objection and Appeal
Prior to agreeing on a settlement, the CRA will often require the taxpayer to sign a waiver to waive their rights of objection or appeal. The basis for the enforceability of such waiver lies in subsections 165(1.2) and 169(2.2). Specifically, if the taxpayer has signed such waiver, subsection 165(1.2) of the Income Tax Act prohibits the taxpayer from objecting to an assessment, and subsection 169(2.2) of the Income Tax Act prohibits the taxpayer from filing a tax court appeal to a waived issue.
Since the principled settlement rule only affects the CRA's ability to reassess a taxpayer in accordance with subsection 220(1), any signed objection and appeal waiver even if not reached on a principled basis, would still be enforceable against the taxpayer by virtue of subsection 165(1.2) and subsection 169(2.2) of the Income Tax Act.
Due to the difference between the enforcement of waivers and the enforcement of tax settlements, our expert Canadian tax lawyers have inserted conditional clauses making the taxpayer consent to the waiver conditional upon the CRA reassessing in accordance with the terms of the tax settlement agreement. Such conditional terms are not included in the standard waiver forms published by the CRA. However, the law is uncertain on whether such conditional waiver would be effective even if the CRA did not assess in accordance with the terms of the settlement.
Pro Tax Tip - Watch out for Principled Settlement Rule when Negotiating with the CRA
Tax dispute with CRA can be a long and stressful process; it would be highly frustrating and costly for a Canadian taxpayer to have finally reached an acceptable settlement with the CRA, only to have it struck down by the principled settlement rule. In that case, the taxpayer may even be barred from further objection and appeal by virtue of the waiver he or she signed as part of the settlement process. Our experienced Toronto Tax Lawyers can guide you through the tax dispute process in order to reach a satisfactory outcome for you and ensure that any written settlement offers made during the course of a tax dispute with the CRA would be made on a principled basis to allow for a favourable cost award if the matter proceeds to trial and is successful. Don't hesitate to call us today to speak us about your tax needs. Your conversation with us will be confidential.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.