Relief from interest accrual requested under the Income Tax Act (Canada) (“ITA”) in a complex and protracted dispute was recently rejected in Walsh v Canada, 2017 FC 411 (“Walsh”), a judicial review (“JR”) decision of the Federal Court (“FC”) issued in April 2017. The bases for the JR were that the CRA omitted to properly consider:
- the extraordinary impact of inconsistent/contradictory assessments; and
- the delays in advancing the tax appeal.
The underlying tax issues giving rise to the relief request began with Glenn Walsh’s reliance on an aggressive tax product that was ultimately not defensible:
- in 1998, Walsh entered into a “departure trade” assisted by CIBC;
- in a departure trade, an interest deduction is created to reduce the income tax burden of a taxpayer who is emigrating from Canada;
- the scheme typically works as follows – the departing taxpayer borrows substantial funds and earns deductible interest before departure; the interest is deductible because the borrowings are reinvested (with the lender); but interest earned on the investment is non-taxable in Canada because it is received after the taxpayer emigrates;
- more specifically, in Walsh’s case, the departure trade was executed as follows:
- Walsh set up a Cayman entity (“Falcon”) and CIBC also set up a Cayman entity (“Phoenix”);
- Walsh borrowed over US$690M from CIBC NY at 8.74%, which loan would mature on January 15, 1999, with the first interest payment due on December 31, 1998;
- Walsh used the loan proceeds to purchase preferred shares of Falcon, which Falcon in turn used to purchase preferred shares of Phoenix;
- on December 29, 1998, CIBC NY loaned Walsh over $47M to make the first interest payment;
- a subsequent series of transactions resulted in the borrowings circling back to CIBC NY, thus, the liabilities were resolved, the Falcon shares were redeemed and Phoenix was dissolved; and
- in his 1998 return of income, Walsh deducted over $47M for interest and carrying charges, to offset income earned through an employee profit sharing plan (“EPSP”) and a taxable capital gain of more than $7M was reported on the deemed disposition of the Falcon shares.
The CRA reassessed Walsh’s 1998 taxation year in October, 2002 to deny the interest deduction and increase the Falcon capital gain to over $48M. The CRA also reassessed his 1999 taxation year to deny a loss carry-forward arising from a loss claimed in 1998. In 2002, the CRA also reassessed corporations Walsh controlled to deny the deductions in relation to the EPSPs. The appeals by Walsh and the corporations ended up before the Tax Court of Canada (“TCC”) by June, 2004.
In 2006, a second set of personal reassessments were issued for Walsh’s 1999 taxation year to include more than $54M in income from non-resident corporations after 1998, on the basis he had not ceased to be a resident of Canada in 1998 – a position not consistent with the prior reassessments. Walsh objected to these reassessments as well. While the inconsistent assessing position seems peculiar at first glance, it is well-established that where the facts in a case are in dispute, the CRA can adopt inconsistent positions, presumably protectively: if one position failed and the other succeeded the CRA would then reassess accordingly. However, the authority to take contradictory positions should not be exercised as a general rule, but rather on an exceptional basis.
The TCC appeals were held in abeyance as a similar departure trade case (Grant) was litigated. The second personal reassessments also caused procedural issues that were put on hold while Walsh’s appeals were held back. The taxpayer in Grant lost his appeal and the result was upheld by the Federal Court of Appeal with leave to appeal to the Supreme Court of Canada denied in 2007. In May, 2007, Walsh’s TCC notice of appeal was amended and over approximately three years the case proceeded, before settling in April, 2010. The settlement resulted in Walsh having a tax liability for the approximately $47M, while the CRA conceded that there would be no deemed dividend on the disposition of the Falcon shares. The EPSP deductions were also allowed for the corporations, thereby reconciling the inconsistent/contradictory assessing positions. Reassessments were issued to implement the settlement in July, 2010. In December, 2012, Walsh requested interest relief in relation to 1998. Partial interest relief was granted in July, 2013, a second administrative review was requested and the initial CRA decision was upheld in December, 2013. Walsh applied for JR of that decision and, in November, 2014, the FC sent the matter back to the CRA for reconsideration. That further reconsideration was not favourable, leading to the further JR application.
Inconsistent / Contradictory Reassessments
Walsh’s position was that the inconsistent/contradictory reassessment constituted extraordinary circumstances or circumstances beyond his control, those inconsistent positions being:
- adjustments to the proceeds for the Falcon shares in the 1998 reassessment;
- the determination Walsh was a resident of Canada in the second 1999 reassessment; and
- the inclusion of the EPSP amounts in Walsh’s 1998 income, but the denial of the deduction for same in the corporations.
The various reassessments resulted in cumulative liabilities of over $110M. In Walsh’s submission, he had no realistic options but to wait for the TCC cases to resolve before being able to act on any of the reassessments and the extraordinarily high reassessments compared to the more moderate settlement amount represented “extraordinary circumstances”. In Walsh’s submission, it was unreasonable to not consider the inconsistent/contradictory positions as “extraordinary circumstances” and the CRA always knew that only one assessing position would survive. Further, while the CRA may be able to take inconsistent assessing positions, the CRA failed to consider the effect on Walsh.
However, the FC pointed out that Walsh omitted to provide any evidence that he had no realistic options when faced with the inconsistent/contradictory reassessments: the sums were large, but it was not clear that he could not pay them. Further, according to the FC, Walsh omitted to provide the CRA with information required to properly assess, could have provided a waiver to avoid the defensive use of inconsistent/contradictory reassessments, or could have produced a settlement offer to deal with his appeals. Thus, paying $110M was not his only reasonable option – he had others and “sticking to his guns” on the appeals was not a matter beyond his control, but rather part of his overall strategy. Therefore, the FC found that the circumstances were not “extraordinary”.
Walsh also submitted that there were lengthy delays with his various appeals and that the appeals could not be separately dealt with while the CRA ran its test case (Grant). However, the FC determined that Walsh was squarely in the category of taxpayer who failed to pay a tax debt pending a decision in a related case (as was the situation in Telfer). Walsh would have known that interest was accruing on any balances and the complexity of the situation and the multiple assessments were matters of Walsh’s own making, which could not later be relied on to absolve him of paying accrued interest.
The FC stated that Walsh should not have to pay interest during a period of undue delay attributable to the Crown, but in his case any abeyances were consented to by both sides and, in fact, Walsh requested timetable extensions and it took him over eight months to amend his pleadings.
The FC found that the CRA’s decision to not give interest relief was not unreasonable, thus dismissing Walsh’s application.
In my view, the challenge for the taxpayer in Walsh was the effect of Telfer. In Telfer, the taxpayer’s notices of objection were held in abeyance pending the outcome of a test case. She had been notified in writing by the CRA that interest would accrue on any unpaid balances. The CRA refused to grant interest relief because there had been no extraordinary circumstances beyond her control and no delay per se since she agreed (or at least acquiesced) to have her objections held in abeyance and had been warned of the interest accrual issue.
Walsh’s representatives did the best with what they had: Telfer posed a challenge and thus they sought to frame Walsh differently, relying on the “paralysis” associated with the CRA’s inconsistent assessing positions and Walsh’s lack of options. The FC did not find Walsh to have been so helpless and, in many ways, the opposite – he was the author of his own misfortune because he: did not provide enough information to the CRA to avoid inconsistent assessing positions nor did he provide a waiver; engaged in a complex set of transactions leading to complexity of assessing positions; was partially responsible for or acquiescent in the delays that caused the appeals to “drag on”; and strategically waited for the result in Grant. One wonders if a case with more compelling facts than Walsh might succeed, where a taxpayer’s options are truly limited by onerous inconsistent/contradictory assessing positions.