It can be a scary proposition to face-off with the Canada Revenue Agency. With the size and power of such a large agency, the consequences of failing to make your case can be financially debilitating.
At the very least a taxpayer should be able to expect fair treatment. Indeed, the Taxpayer Bill of Rights, as published on the CRA website, expresses the duties incumbent on the CRA.
However, as a taxpayer learned in a recent case from the BC Supreme Court, proving that the CRA did not live up to those duties does not guarantee ultimate success in court.
Mr. L and the RV Park
In 1989 Mr. L purchased forested land in the British Columbia interior that he felt would be suitable for establishing an RV Park business. By 1993 he had begun clearing the land for the intended use, selling the logs to a local sawmill. The following year he cleared more land that he eventually subdivided and sold, in part to finance the business.
In 1996, Mr. L was the subject of a GST audit for his 1993, 1994 and 1995 tax years. The investigation of the business records led to a review of his income tax returns as well. Eventually Mr. L received a letter in September 1997 proposing adjustments to both the GST and income tax returns.
Some of the dispute was about personal versus business expenses, but a large part dealt with whether the logging activity was capital or business income.
After a series of CRA collections procedures, liens and sale of the property under receivership, Mr. L succeeded on appeal to the Tax Court in 2005. However, it took a “fairness” application in 2006 to obtain a waiver of the remaining interest and penalties, resting in part on CRA delays during audit and objection.
Suing the CRA
Later in 2006 Mr. L launched an action for negligence against the CRA, focused on the three auditors he had dealt with over the years. In order to succeed, he would have to prove:
- a duty of care was owed to him from CRA,
- breach of the standard of care,
- a causal link between the breaches and a loss, and
- a quantification of those losses, or ’damages’.
Given the clear and potentially devastating consequences for Mr. L, the judge held there was a duty to take reasonable care to avoid doing him harm. The appropriate standard to measure against was that of “a reasonably competent tax auditor in the circumstances.”
While the judge found that the assessment of the logging activities was based on “erroneous and unsupported assumptions”, Mr. L did not fulfil his own onus to clarify the record. And though that characterization turned out to be wrong, it was “not a breach of the standard of care, given the information available to [the auditors] at the time.”
However, the judge saw the penalties in a different light:
- The assessment was based on what Mr. L “ought to have known”, whereas the relevant section of the Income Tax Act uses the words “knowingly” or “grossly negligent”.
- Penalties were assessed on the whole of the income rather than on each alleged offending issue. For 1995, it was $51,682 on $5,787 tax due — a 900% penalty.
- Finally (or firstly?), the original auditor threatened Mr. L with gross negligence penalties if he did not sign a waiver allowing for the audit of the (otherwise statute-barred)1993 tax year.
And damages for the taxpayer?
Despite showing breach of the standard of care, Mr. L could not succeed unless he could show a causal connection between that and his losses. Much of that rested on the registration of income tax and GST judgments against the property.
On the evidence, the judge determined that the business was in difficult financial straits even before any judgments were registered. On top of that, Mr. L’s own delays worked against him, in particular failing to file his income tax appeal on time. And in the case of the GST, matters would have been resolved sooner if he had better records and disclosed them sooner.
Thus, though able to prove the CRA auditors breached the standard of care, Mr. L was not able to recover any damages.
