In Preston Family Trust II v The Queen, the taxpayers were a trust resident in Canada (the "Preston Family Trust") and two non-resident beneficiaries of the trust, John and Monika Preston. Just before the 21st anniversary (ed. note: see the "21-year rule" of trusts in Canada) of the Preston Family Trust, John and Monika Preston became sole shareholders of an Alberta Unlimited Liability Corporation ("ULC"), to which they assigned their capital interests in the Preston Family Trust and to which the trust transferred all of its capital properties, consisting of shares of a holding company and partnership interest.
The Canada Revenue Agency (CRA) assumed the ULC never became a beneficiary of the trust and that John and Monika Preston continued to be beneficiaries of the trust even after the assignment of their capital interests in the trust to the ULC. The CRA then assessed about $12 million in tax to the trust on the theory that it had realized gains from the disposition, deemed to have been made at fair market value, of its capital property to non-resident beneficiaries in 2014.
The CRA also assessed the two beneficiaries in respect of certain dividends deemed to have been paid by the holding company in 2014 for approximately $2 million in tax. The taxpayers then brought motions to strike out certain assumptions of the CRA in the replies to the taxpayers' notices of appeal made by the Department of Justice's Canadian tax lawyer acting for the CRA.
The Tax Court sided with the taxpayers and ruled that the CRA should rephrase their reply because the taxpayers only had the onus of disproving the assumptions of fact made by the CRA, but not the onus to go further and disprove the CRA's conclusions of law or legal elements.
Subsection 49(1) of the Tax Court Rules governs the facts set out in the Respondent's (CRA's) reply
Subsection 49(1) of the Tax Court Rules requires the Respondent's reply to have two parts. The first part requires the Respondent to set out the facts which include assumptions of fact made by the CRA. This part of the reply includes the facts the Respondent admits, denies and of which the Respondent has no knowledge and puts it in issue. In the second part, the Respondent is required to relate the facts to the law. In this part, the Respondent has an opportunity to describe how the law applies to the facts pleaded in the first part of the Reply.
The Tax Court of Canada then reviewed case law and clarified that taxpayers only have the onus of disproving the assumptions of fact made by the CRA but have no onus to go further and disprove the CRA's conclusions of law or the legal elements of the CRA's conclusions of mixed fact and law. In Anchor Pointe Energy Ltd. v R, the Federal Court of Appeal explained that:
- The pleading of assumptions gives the Crown the powerful tool of shifting the onus to the taxpayer to demolish the Minister's assumptions. The facts pleaded as assumptions must be precise and accurate so that the taxpayer knows exactly the case it has to meet ... the Minister should extricate the factual components that are being assumed so that the taxpayer is told exactly what factual assumption it must demolish in order to succeed. It is unsatisfactory that the assumed facts be buried in the conclusion of mixed fact and law.
Therefore, the CRA may not plead a conclusion of mixed fact and law as an assumption of fact.
The onus shifts back to the CRA once the taxpayer demolishes the CRA's assumptions
In Hickman Motors Ltd. v R, the Supreme Court of Canada specified that once the taxpayer meets the initial onus to demolish the CRA's assumptions of fact by making a prima facie case, then the onus shifts to the CRA to rebut the prima facie case. If the CRA adduces no evidence, then the taxpayer is entitled to succeed. The term "prima facie" case was defined in Stewart v Minister of National Revenue by the Tax Court of Canada as one supported by evidence which raises such as degree of probability in its favour that it must be accepted if believed.
The Tax Court struck certain assumptions of fact from the CRA's reply
The Tax Court found there were certain paragraphs from the CRA's reply that were essentially conclusion of mixed facts and law pleaded as assumptions of fact. The court then ruled to strike off the following from the assumptions of fact:
- The reply mentioned John and Monika Preston continued as beneficiaries of the Preston Family Trust even after having assigned their capital interests in that trust to the ULC. This was both a factual assumption and a legal argument.
- Regarding who could or could not have been beneficiaries of the trust, the reply mentioned the appellant's beneficiaries could only be natural persons and could not be corporations. The court found that limiting the application of this legal conclusion to the trust did not make it an assumption of fact.
- Regarding the extent of trustee discretion, the reply mentioned the trustees did not have discretion to vary the terms of the Preston Trust Deed or to add new beneficiaries of the appellant. This was a conclusion of law instead of an assumption of fact.
- Regarding the use of the phrase "received ... for the benefit of", it indicated conclusion of mixed facts and law because the CRA concluded that John and Monika Preston were the beneficiary owners of the property distributed by the trust.
- As for the use of certain deeming provisions of the Income Tax Act in the reply, the Tax Court found the effect of these deeming rules reflected conclusions of mixed fact and law.
- Regarding the use of "fair market value", "adjusted cost base", "taxable capital gain", the court ruled that the CRA arrived at a conclusion of mixed facts and law by applying the legal meaning of these terms.
- As for the CRA's computation of the amount of tax payable under the Income Tax Act, the court found the this was neither an assumption of fact nor statement of facts. It simply reflected the result and could not be pleaded in the paragraph that set out assumptions of facts.
The assumption of fact is not the place for the CRA to plead conclusions of law or mixed facts and law
Paragraph 49(1)(h) of the Tax Court Rules requires that every reply from the CRA include the reasons upon which the CRA intends to rely, but the paragraph for the assumptions of fact is not the place to insert those reasons.
David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm and is a Certified Specialist in Taxation Law who has completed the CICA in-depth tax planning course. He appears regularly in print, radio and TV and blogs extensively.
With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, cryptocurrency traders, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax audit representation and tax litigation. Visit www.Taxpage.com and email David at firstname.lastname@example.org. Read the original article on Taxpage. Photo David Rotfleisch courtesy Rotfleisch & Samulovitch P.C.