Written by Alison Gray
In 2007, the CRA reassessed the taxpayer for four taxation years on the basis that it failed to report income in each of those taxation years (the 2007 Reassessment). For one taxation year, 1996, the taxpayer reported $1.2 million of income, to which the CRA added $600,000 of unreported income for a total of $1.8 million. The CRA eventually admitted that $200,000 of the additional $600,000 in income should not have been made. The maximum amount of income the CRA could have added as unreported income was $403,219, which it admitted in responding to the appeal.
The taxpayer settled with the Crown on the basis that (i) the CRA would vacate the reassessments for three of the reassessed taxation years, and (ii) the CRA would reassess the 1996 taxation year to add $403,219 to the taxpayer's income and impose a penalty under subsection 163(2) of the Income Tax Act (the ITA). Minutes of Settlement were entered into between the parties on these terms.
Following the settlement, the CRA issued a reassessment that showed the taxpayer's income for its 1996 taxation year to be $2,266,291, which was $403,219 plus the 2007 Reassessment amount of $1.8 million (the 2012 Reassessment). The taxpayer complained the 2012 Reassessment did not conform to the terms of settlement, which was to add $403,219 to its reported income of $1.2 million.
The Tax Court declared the 2012 Reassessment void and vacated it on the basis that it was arbitrary.
The Tax Court first found the 2012 Reassessment was not supported by the facts and the law. The Court held there was no factual or legal basis to support the contention that the taxpayer's income for the 1996 taxation year could be $2,266,291, and rejected the CRA's argument that "the Appellant offered more and we accepted it" as without merit. In so finding, the Court emphasized that settlements must conform to the long-standing principle that they be justified under, and in conformity with, the ITA, and cannot be based on mere compromise. Rather, a settlement must be a principled one that can legally and factually support a reassessment.
The Court also held that the 2012 Reassessment offended the well-established principle that the Minister cannot appeal its own assessment. The CRA conceded that the 2012 Reassessment was not a result that could have been reached on an appeal of the 2007 Reassessment. However, it argued that subsection 169(3) of the ITA permits the CRA to increase the amount of tax that it could reassess despite subsection 152(5) of the ITA. The Court rejected this argument, reaffirming that a reassessment cannot be issued that results in an increase of tax beyond the amount in the assessment under appeal.
The Court also rejected the suggestion that the word "income" in the Minutes of Settlement was ambiguous. The Court relied on principles of contractual interpretation to consider the "factual matrix" surrounding the settlement and concluded the contract was valid, as it could reasonably be expected that the CRA would have known that the addition of $403,219 was to be added to the appellant's income as originally reported (i.e., $1.2 million) and not to the income amount in the 2007 Reassessment (i.e., $1.8 million).
The Court found that the settlement was valid and held the Minister should reassess on the basis that $403,219 should be added to the taxpayer's income for the 1996 taxation year as originally reported. The Court concluded it had the jurisdiction to vary the 2007 Reassessment, given the invalidity of the 2012 Reassessment, and because a discontinuance of the appeal of the 2007 Reassessment had not been filed.
The Take Away
The Court's decision was not unexpected. This was a clear attempt by the CRA to take advantage of a less than precise settlement agreement to collect more tax than it was entitled. The decision does underscore, however, the need to be as precise as possible when entering into settlements and reducing the terms to writing.