CRA Wins as FCA Backs Down on Crown Costs Issue

Courts generally have the power to award costs against unsuccessful parties. These cost awards can be more severe depending on the conduct of the parties, and they are, therefore, a great way to dissuade frivolous litigation.

The Tax Court of Canada (TCC), in a rare move much to the delight of many observers, used its power to do so against the Canada Revenue Agency (CRA) in the 2013 case of Martin v.The Queen. The ruling from the TCC could have served as a precedent to dissuade the CRA from pursuing certain lines of argument and procedure in pre-trial proceedings at the expense of the taxpayer.

Recently, however, the Federal Court of Appeal (FCA) reduced the cost award in that case from $10,635 to $4,800 due to a narrow interpretation of the TCC Rules. This result is unfortunate for taxpayers. Here’s what happened:

When the TCC originally heard the case, it described the facts and circumstances as “very unusual, difficult, and hopefully exceptional”. The taxpayer successfully challenged a section 160 assessment (a non-arm’s length transaction allegation) in respect of certain amounts paid to her by her spouse.

There was evidence to suggest that the CRA auditor had deliberately misled the taxpayer during an audit. As a result the taxpayer spent considerable time and a lot of money during the audit and objection process. The taxpayer eventually prevailed at trial.

The TCC held that costs may be awarded against the Crown where it pursues a meritless case against a taxpayer in court. It was stated:

There are perhaps some arguments and some cases that the Canada Revenue Agency just should not pursue. The Crown is not a private party. By reassessing a taxpayer and failing to resolve its objection, the Crown is forcing its citizen/taxpayers to take it to Court. If the Crown’s position does not have a reasonable degree of sustainability, and is in fact entirely rejected, it is entirely appropriate that the Crown should be aware it is proceeding subject to the risk of a possibly increased award of costs against it if it is unsuccessful.

But, there was a fly in that ointment when the appeal was heard at the Federal Court of Appeal. This Court noted that conduct that occurs prior to a proceeding may be taken into account when determining costs awards after trial if such conduct unduly and unnecessarily prolongs the proceeding.

However, it also stated that the audit and objection stages are not a “proceeding” as defined in section 2 of the Tax Court Rules. Accordingly, the FCA held that the TCC “erred in principle in allowing an amount incurred in respect of costs unrelated to the appeal which were incurred at the objection stage.”

This decision by the FCA is disappointing for taxpayers. It is arguable that the TCC has more discretion than the FCA was willing to admit. For instance, Rule 147(3)(j) of the Tax Court Rules states that the Court may consider “any other matter relevant to the question of costs.”

The FCA, however, decided that the TCC did not have the power to penalize the CRA for its actions in the audit stage. Even though the Crown might not be dissuaded by the threat of increased cost awards as much as a private party would be, the ruling in the TCC provided some comfort for taxpayers that the courts would stick up for them if the CRA was being unreasonable and causing unnecessary burdens.

In conclusion, it is certainly unfortunate that the FCA decided to read the powers of the TCC sharply and thereby diminish its ability to remedy unreasonable behaviour of the CRA in pre-trial proceedings.

If the original ruling in the TCC had been affirmed by the FCA, there would have been a very solid precedent for costs awards against the CRA for unreasonable actions in the pre-trial stages, such as the audit and objection stages.

However, as a result of the actual FCA ruling, taxpayers cannot be compensated from costs incurred in certain pre-trial stages and the CRA will not be dissuaded from pursuing arguments that have little chance of succeeding, even though the taxpayer must incur considerable expenses in attempting to defend against them. 

Greer Jacks is a lawyer with Crease Harman LLP, Barristers and Solicitors in Victoria, BC.