NATIONWIDE – CANADA: An Introduction to Tax: Litigation

A Year of Significant Change in the Tax Realm

The Canadian tax litigation landscape has seen many changes in 2024, including entirely new tax regimes created in the Digital Services Tax Act and the Global Minimum Tax Act, and significant changes to substantive tax rules, like the General Anti-Avoidance Rule (GAAR).

On the administrative front, the Canada Revenue Agency (CRA) continues to benefit from increased funding and expanding audit powers. In the courts, there has been significant change to the composition of the judiciary deciding tax disputes.

These changes increase uncertainty around taxpayers’ obligations, the limits on the CRA’s powers, and how taxpayers may fare if they proceed to litigation. Due to the inherent uncertainty created by this new landscape, many companies are likely to be dragged into tax disputes in the coming years while these new rules and their application are defined by the courts.

New substantive tax rules

Many recent changes to Canadian tax law are likely to require clarification from the courts. First, the Digital Services Tax Act and the Global Minimum Tax Act came into force in 2024, introducing broad new concepts.

Second, recently passed provisions, including the excessive interest and financing expense limitation rules, mandatory disclosure rules, and the extended disclosure of uncertain tax positions, are now being grappled with by taxpayers who are seeking to comply in the face of novel regimes.

Third, changes to GAAR, which became law in 2024, are likely to spawn a long line of disputes because they introduce the explicit adoption of “economic substance” that will need to be considered when deciding whether transactions are abusive. Canadian taxpayers, administrators and courts will now be forced to reach conclusions on whether the particular transactions at issue have sufficient economic substance. Notably, the revised GAAR includes both a penalty and extended limitation periods for GAAR reassessments in certain circumstances.

Fourth, substantive changes are also on the horizon for Canada’s transfer pricing rules, which if passed, would likely lead to further disputes.

Increases to audit powers

With increased funding over the last four years resulting in significant employment growth to approximately 60,000 employees, the CRA continues to focus on audit activity. The CRA has been granted increased audit powers (to compel interviews, among other things), and the Department of Finance has proposed to expand these powers even further. The proposed changes would permit the CRA to determine whether a taxpayer is non-compliant during the course of an audit, subjecting the taxpayer to penalties and extended limitation periods.

Proposals also enable the CRA to force individuals to answer questions under oath, which brings a host of further complexity to its recently provided interview powers.

The courts historically sought to give the CRA broad discretion to audit while ensuring taxpayers are treated with some minimum level of fairness or reasonableness; presumably judges will bear the same concepts in mind when called upon to interpret revised or new audit powers for the first time. 

Clarified standards for judicial review

Increased judicial review of the CRA’s discretionary decisions is expected in the coming years, in light of recent jurisprudence. First, the Supreme Court of Canada’s decisions in Dow Chemical and Iris Technologies, followed by the Federal Court’s decision in Milgram Foundation, demonstrate that there is still uncertainty in selecting the best course of action in addressing tax disputes or disagreements with the CRA’s decisions, and that judicial review is readily available.

Second, the Supreme Court provided further guidance on what it means for decision-makers like the CRA to have come to “reasonable” conclusions, in cases such as Vavilov, and in Mason. These concepts have already begun to be applied by the Federal Court when reviewing the CRA’s decisions.

Changes in the judiciary

All levels of the tax judiciary have seen substantial overhaul in recent years, including in 2024. The Supreme Court, in a span of 12 years, has an entirely new bench composition: none of the justices that heard the recent GAAR appeal Deans Knight, for example, were on the bench when the seminal GAAR appeals, Canada Trustco and Copthorne, were decided.

At the Federal Court of Appeal (which hears appeals from the Tax Court), a number of individuals with substantial tax expertise have been appointed in recent years. A taxpayer proceeding to the Federal Court of Appeal now has reasonable odds of at least one of the judges on the panel having real-world, lived tax experience. Hopefully this will ensure that the new rules are interpreted in a way that is practical and workable for those “on the ground”.

The year 2024 also marked major changes in the Tax Court, including the appointment of a new chief justice and the retirement (or transition to supernumerary) of many justices who historically heard many of the largest Tax Court cases. A large proportion of the Tax Court’s judges will be new to the bench when hearing cases in coming years, in light of recent appointments from both the Department of Justice and the private bar. There remains a considerable vacancy on the Tax Court bench, which may result in further delays to the scheduling of hearings and addressing the backlog of cases at the court.

Litigation trends

In respect of income tax, the CRA continues to frequently allege shams are being perpetrated, transactions are legally ineffective, and that GAAR should be applied (each with mixed success).

On the procedural front, the Tax Court has continued a trend of imposing discipline on pleadings (and particularly the requirements that must be met with respect to a reply). Refusals motions continue to be litigated somewhat frequently, and privilege claims continue to be tested by the CRA.

In respect of indirect tax, many recent decisions focused on whether goods or services are single or multiple supplies, and how loyalty programmes should be treated for harmonised sales tax (HST) purposes. The CRA continues to allege that certain taxpayers have entered into transactions where the party named on the invoice is not the true supplier of the good or service in question, and thus input tax credits should be denied.

Conclusion

The year 2024 has been one of new regimes and tax rules, new audit powers, new judges and new guidance on judicial review. Between these changes, and evergreen arguments about sham, legal effectiveness, GAAR, single or multiple supplies, and who the “true supplier” of goods or services is, it seems many disputes will be inevitable in 2025 and onwards.