Posted February 17 10 at 5:21 am

Introduction: Audits, Objections, and Tax Court

The “appeal process” is the term commonly used to refer to all stages available to a taxpayer to dispute a reassessment of their Notice of Assessment for a given tax year, which is often the result of a desk audit—as opposed to a field audit—(as is in  the case of tax shelters).

In fact, the “appeal process” comprises three processes:

[1] Audit Stage

[2] Objection Stage; and

[3] Tax Court Stage.

Most non-tax-shelter disputes with the CRA are resolved either at the audit or the objection stage. With tax shelters, the Tax Court presence the truest test of the appeal process.

In fact, a taxpayer cannot file an appeal to the Tax Court until certain steps at the audit and objection are completed. It is important to understand the audit and objection stage, therefore, in order to understand the Tax Court process.

Audits

An audit (or review) usually looks like this:

• A “taxpayer” (usually an “individual” and not a corporation in the context of tax shelter or RPGA participation) files a T1 return.
• The CRA usually issues a Notice of Assessment, with “due dispatch” (expeditiously) without an in-depth “audit” or “review”. This initial assessment does not indicate that the CRA is satisfied with the return. Initial assessment starts the three year limitation (statute-barred) period running. In general, absent a misrepresentation or fraud, the CRA cannot reassess an individual taxpayer more than three years after the date of the initial assessment, and keep in mind that it does take some time to commence, correspond, and complete an audit.
• For algorithmic reasons best known to itself (statistically determined), the CRA selects the taxpayer’s return for a review or audit. Where a taxpayer participates in a registered tax shelter, which has a tax shelter identification number (similar to a S.I.N.), the audit is actually of the tax shelter and not of the taxpayer; however, that is more semantic than it is real, as the result will be applied to the taxpayer relative to their quantum of participation in the shelter. What is important is that the audit, since it is only of the tax shelter, will not result in an audit of any affairs in the individual taxpayer’s other affairs.
• At this stage of discovery, the auditor’s powers are quite broad. In general, almost any question or any demand for documentation, as long as it reasonably relates to the taxpayer’s liability under the Income Tax Act is fair game. Throughout the review or audit, the taxpayer has the opportunity to rebut any suspicions or concerns the auditor might have.
• The auditor issues a proposal letter, which sets out the auditor’s proposed reassessment. The letter generally allows the taxpayer 30 days to make submissions against the proposed reassessment.
• After reviewing the taxpayer’s final submissions, if any, the auditor prepares an audit report (usually called a “Form T20?) that provides the factual and legal basis (based on facts and on law) for the proposed reassessment.
• The auditor’s team leader reviews and approves the form T20.
• A notice of reassessment is issued to the taxpayer, usually with a form T7W-C that summarizes the adjustments made by the reassessment. The reassessment replaces the assessment originally issued to the taxpayer, and it fixes the taxpayer’s liability for tax under the Act unless the taxpayer successfully disputes it by filing an objection or, if that step is unsuccessful, by filing an appeal to the Tax Court.

Objections

To dispute a reassessment, a taxpayer must file an objection. The taxpayer cannot appeal directly to the Tax Court. The following describes the objection process.

• The taxpayer begins the process by completing a notice of objection in writing and sending it by mail or delivering it to the Chief of Appeals “in a District Office or Taxation Centre” (see subsection 165(2) of the Act). The CRA has created a form for objections (the T400A), but the Act does not prescribe this form, and so it is not necessary to use it (see Lester v. The Queen, 2004 TCC 179, where a letter was held to constitute a valid notice of objection). To avoid confusion and to ensure that the objection is not misdirected somehow, it is advisable to use the CRA’s form. The objection must be filed on the day that is 90 days after the day of mailing of the notice of reassessment or, in the case of an individual or a testamentary trust, on or before the later of (1) the day that is 90 days after the day of mailing of the notice of assessment and (2) the day that is one year after the taxpayer’s filing-due date for the year for which the reassessment was issued. Section 166.1 of the Act allows a taxpayer to apply to extend the time for filing a notice of objection. The taxpayer, however, among other things must make the application within one year “after the expiration of the time otherwise limited by this Act for serving a notice of objection.” David Sherman, in his notes on section 166.1 in The Practitioner’s Income Tax Act, states that in the year ended March, 2004, the CRA accepted 91% of all applications made under section 166.1.
• The CRA sends a letter to the taxpayer (with a copy to the taxpayer’s representative) acknowledging receipt of the notice of objection. In Hamilton, it can sometimes take the local “District Office” (Tax Services Office) months simply to send such a letter.
• The Chief of Appeals assigns the objection to an appeals officer for review. The appeals officer reviews the objection, the taxpayer’s submissions, the tax return in question and the auditor’s report and working papers. The appeals officer also reviews the provisions of the Act, case law and the CRA’s own publications on the law.
• The appeals officer usually asks the taxpayer for further submissions or additional documentation or information.
• The appeals officer usually sends a proposal letter outlining the CRA’s position.
• The taxpayer can make final submissions.
• The appeals officer prepares an appeals report (usually on form T401) setting out the officer’s conclusions on the facts and law and the disposition of the objection. The officer can reverse, vary or confirm the reassessment under objection.
• The appeals officer’s team leader reviews and approves the report.
• The CRA issues either a new notice of reassessment and T7W-C to vary or reverse the reassessment under objection or a notice of confirmation confirming that the reassessment under objection was correct as far as the CRA is concerned.
• If the taxpayer wishes to dispute the new reassessment or the reassessment that was confirmed, the taxpayer can file an appeal with the Tax Court of Canada.

TAX COURT

1) Notice of Appeal

Description:

A taxpayer (the appellant) commences an appeal to the Tax Court by filing a notice of appeal and paying the appropriate filing fee. Among other things, the notice of appeal sets out the material facts relied on (but not the evidence), the issues to be decided, the statutory provisions relied on and the reasons why the appeal should be allowed (why the appellant should succeed).

Timing:

Within 90 days of the confirmation of the taxpayer’s notice of objection or a reassessment following objection; or more than 90 days after serving the notice of objection (where no confirmation or reassessment has yet been issued).

2) Service of notice of appeal

Description:

The Tax Court registrar serves the notice of appeal on the Department of Justice—the CRA’s lawyer (the respondent)—and sends a certificate of service to the appellant

Timing:

“Forthwith” after the notice of appeal is filed

3) Reply

Description:

The respondent (CRA/Justice) must file a reply to the notice of appeal. Among other things, the reply states the facts that are admitted by the respondent, the facts that are denied, the facts of which the respondent has no knowledge and puts in issue, the findings or assumptions of fact made by the Minister when making the assessment, any other material fact, the issues to be decided and the reasons why the appeal should be dismissed (why the respondent should succeed).

Timing:

The respondent must file the reply within 60 days after service of the notice of appeal and serve it within 5 days after the expiry of that 60-day period.

4) Answer

Description:

The appellant may (but need not) file an answer. Among other things, the answer identifies the new facts raised in the reply that are admitted, the new facts that are denied, the new facts of which the appellant has no knowledge and puts in issue and any other reasons the appellant intends to rely on. If the appellant does not file an answer, then he or she is deemed to deny all of the allegations of fact made in the reply.

Timing:

Within 30 days after service of the reply.

5) List of documents

Description:

Each party must file and serve a list of documents identifying all of the documents of which the party has knowledge at that time that might be used in evidence by the party. A party need not list every relevant document unless the parties otherwise agree or the court so orders. In general, however, both sides will ask for all relevant documents at the examination for discovery.

Timing:

Within 30 days after the close of pleadings. In practice, however, the exchange of the list can take months until the Court intervenes to impose a specific deadline.

6) Examinations for discovery

Description:

Each party is entitled to ask the other party any relevant question about the case either in written form or orally in front of a court reporter while the person answering questions is under oath. Discoveries should narrow the issues between the parties and allow each side to understand the other’s case.

Timing:

No specific deadline. In practice, the Court will often intervene to impose a deadline on the parties.

7) Undertakings

Description:

Frequently, a party cannot answer a question asked at an examination for discovery or produce a document requested. As a result, the party will “undertake” to provide an answer or produce the document at a later date. In addition, each party has an ongoing obligation to provide information subsequently obtained that corrects or completes an answer given on discovery.

Timing:

“Forthwith” after discovery. In practice, the Court will often impose a deadline on the parties for completing undertakings. The obligation to correct or complete answers subsists until the hearing.

8 ) Discovery of non-parties.

Description:

Sometimes neither party has all of the information needed to answer questions asked at a discovery. As a result, one or both parties can apply to the Court for an order requiring a third-party to attend and give answers under oath respecting matters relevant to the appeal.

Timing:

No specific deadline.

9) Written offer of settlement

Description:

A written offer of settlement is usually made to try to settle the appeal without a hearing. A party who makes such an offer and who succeeds at trial will usually try to rely on having made a written settlement offer to obtain a higher award of costs (reimbursement for having had to proceed to trial).

Timing:

At any time.

10) Joint application

Description:

The parties can apply jointly to the Court for a hearing date.

Timing:

After the close of pleadings. In practice, the parties will not apply for a trial date until after discoveries are complete.

11) Pre-hearing conference

Description:

The parties can apply to the Court for a pre-hearing conference at which a judge (who will not hear the appeal) can provide a frank assessment of each side’s case in front of the parties and with counsel present. The purpose of the conference is to encourage settlement or to narrow the issues between the parties. Where the parties have requested three or more days for a hearing, the Court will usually order a conference to try to reduce the length of the trial.

Timing:

After the appeal has been set down for hearing.

12) Hearing

Description:

The Tax Court sits in cities across Canada including Hamilton and St. Catharines. In Hamilton, the Court will usually use space at the John Sopinka Court House.

Timing:

As and when ordered by the Court.

13) Appeals are possible with leave to appeal up to the Supreme Court of Canada.

Note: Most cases are settled before they proceed to Tax Court

Interest, and penalties

Clock ticking during Objection and Appeal

Reassessed amounts are not subject to collection during the appeal process. In other words, you do not have to pay taxes under objection until you have had an impartial review by the CRA or, if you have filed an appeal, until the Tax Court of Canada has issued its decision. If the CRA considers that the collection of the amount is in jeopardy, the CRA will apply to the court for approval to start immediate collection action. Should you lose your appeal at the Tax Court of Canada, you may appeal the decision to a higher court. However, you will be required to pay the disputed taxes in full or post acceptable security. Furthermore, in the eyes of the CRA, interest will continue to accumulate during this period; however, if you pay and then prevail in the process, the CRA will return the interest plus prescribed interest. Should you lose, you will have stopped the interest clock. Should the taxpayer lose and did not pay the interest immediately upon reassessment, s/he can ask the judge that interest be waived.

Frivolity Penalty

The courts are empowered under section 179.1 of the Income Tax Act to impose a penalty of 10% of tax when an appeal proves to be frivolous or groundless and one of the main purposes for appealing was to defer the payment of tax.

Deductibility of Fees. Interest, and Penalties

When can a taxpayer deduct fees paid to contest an assessment or reassessment? As is usual in tax matters, the answer is neither simple nor obvious.

Paragraph 60(o) of the Income Tax Act provides that a taxpayer, in computing income for the purposes of the Act, may deduct:

amounts paid by the taxpayer in the year in respect of fees or expenses incurred in preparing, instituting or prosecuting an objection to, or an appeal in relation to […] an assessment of tax, interest or penalties under this Act or an Act of a province that imposes a tax similar to the tax imposed under this Act

The CRA, in IT-99R5, also permits taxpayer to deduct

amounts expended in connection with legal and accounting fees incurred for advice and assistance in making representations after having been informed that the taxpayer’s income or tax for a taxation year is to be reviewed, whether or not a formal notice of objection or appeal is subsequently filed.

The CRA also points out that the fees in question need not be paid to a lawyer; fees paid to an accountant in the course of an audit or objection should be deductible as well.

Paragraph 60(o) permits a taxpayer who appeals a reassessment to a court to deduct fees awarded against him by the court. See CRA technical interpretation number 2000-0042175 dated November 20, 2000.

Paragraph 60(o) does not apply to GST or provincial sales tax assessments. Fees incurred to contest such an assessment could be deductible under subsection 9(1) of the ITA, but only if the person assessed is carrying on the business.