Most people have had the experience of entering into a bad deal at least once. Perhaps the agreement appeared fair at the outset, but then subsequent information revealed an inequity. In this circumstance, it can be tempting to try to find a way out of the agreement. But barring any misrepresentation or renegotiation, there are limited options for reneging, thereby compelling the aggrieved party to comply with agreed-upon terms.
For tax disputes – whether at the audit stage, the objection stage or the Tax Court stage – tax authorities maintain that Galway v. MNR (74 DTC 6247 (FCA)) can be relied on to withdraw from a settlement. Galway provides that a settlement must be principled, i.e., one that applies the relevant law to the agreed facts. In other words, parties cannot simply settle a tax dispute based on a compromise (e.g., an arbitrary amount of tax). The issue in Galway was whether $200,500 the taxpayer received was income: either the entire amount was income and was taxable, or the amount was not income and was not taxable. To settle the matter, the taxpayer and the Minister reached an agreement that $100,000 of the amount would be taxable, but the compromise did not result in an application of the law to the facts. The parties filed a request for consent to judgment. The Federal Court of Appeal (FCA) refused to issue a judgment in accordance with the parties’ consent on the basis that it could not issue a judgment that did not apply the law to the parties’ agreement of the facts, in other words, because the parties’ agreement did not have a principled basis.
In Canada v. CBS Canada Holdings Co. (2020 FCA 4), the Crown attempted to rely on Galway to withdraw from a settlement agreement it had entered into with CBS Canada Holdings Co. (CBS). In rejecting the Crown’s appeal, the FCA confirmed that Galway is more restricted in scope than the Crown claimed.
CBS, through its predecessor corporations, reported non-capital losses in the 1999 to 2002 taxation years. A large portion of the non-capital losses were a result of the predecessor corporations’ rental-payment obligations. CBS carried forward $33 million of non-capital losses to its taxation years ending March 7, 2007 and December 31, 2007. The Minister reassessed CBS on the basis that its predecessor corporations were not entitled to deduct the rental-payment obligations in the 1999 to 2002 taxation years and, therefore, the Minister reduced the non-capital loss carryforward from $33 million to $1.4 million.
CBS appealed the reassessments to the Tax Court of Canada (TCC). Approximately one year later, and before the appeal was even scheduled for hearing, CBS offered to settle the appeal. CBS would accept the Minister’s disallowance of the rental-payment obligations in the 1999 to 2002 years and, consequently, the reduced non-capital loss carryforward from these years, and the Minister would accept that CBS had an additional $24 million of non-capital losses in the 2002 to 2007 years that CBS could carryforward to the March 7, 2007 taxation year.
The Crown accepted CBS’ offer. The minutes of settlement set out (1) the facts to which the parties agreed and (2) the parties’ agreement as to how the law would apply to these facts. In other words, the agreement had a principled basis and included the following provisions:
- The majority of the $33 million of rental obligations incurred in 1999 to 2002 are not deductible as claimed by CBS.
- The reduced non-capital loss carry forward balance of $1.4 million is to be applied to the 2002 to 2007 taxation years.
- The Minister is to reassess the taxation year ended March 7, 2007 to allow an additional non-capital loss carry forward in the amount of $24 million. (paragraph 11)
After signing the minutes of settlement but before issuing the notices of reassessment, the Crown informed CBS that “[c]ontrary to its prior understanding, the CRA has recently discovered that there are no non-capital losses available for carryforward” (paragraph 12) and that the Minister could not issue the additional non-capital loss carryforward of $24 million reassessment in accordance with the minutes of settlement. Simply put, the Crown no longer agreed with a key fact on which the minutes of settlement were based and, therefore, took the position that the settlement was not principled.
CBS asked the TCC to enforce the minutes of settlement. In response, the Crown provided an affidavit from the CRA appeals officer stating that CBS did not have the additional non-capital losses of $24 million and that the Crown had erred in including that statement in the minutes of settlement. The affidavit did not provide details related to the mistake and did not provide support for CRA’s position that CBS did not have additional non-capital losses. The TCC allowed CBS’ motion and enforced the minutes of settlement. The Crown appealed the TCC’s decision to the FCA.
The Federal Court of Appeal
The Crown’s primary argument was that the TCC erred in enforcing the settlement because the settlement was “factually and legally indefensible, and as such the Minister is precluded from issuing the proposed reassessments”(paragraph 20). The Crown cited Galway to support its legal position and relied on the CRA appeals officer’s statement that CBS did not have additional non-capital losses to carryforward from the 2002 to 2007 years to support its factual position.
However, the FCA held that Galway was not as broad as the Crown alleged and that it did not preclude the Minister from issuing reassessments in accordance with the settlement. In particular, the FCA held that Galway did not apply for several reasons:
- Galway allows the Court to intervene on its own when both parties seek the court’s approval of an agreement; in CBS, the Crown unilaterally sought to withdraw from the parties’ agreement.
- Galway bars the parties from reaching a compromised settlement and instead, requires that they reach a principled settlement (one that applies the law to the agreed facts); in CBS, the settlement terms clearly apply the law to the facts the parties had agreed to at the time they executed the minutes.
For these reasons, the FCA dismissed the Crown’s appeal, thereby enforcing the parties’ agreement.
Understanding the scope of Galway and of taxpayer rights when settling a tax dispute
CBS Canada Holdings reveals that Galway does not provide the Crown with a mulligan when the Crown alleges to have made an error or to have uncovered new information after executing an agreement. This is welcome news for taxpayers. Galway still stands for the proposition that settlements must have a principled basis. However, the determination of whether a settlement is principled is to be made at the time the parties execute the settlement. Therefore, parties should be diligent and understand that the facts on which they base the settlement terms are considered to be accurate notwithstanding any errors or facts that are uncovered subsequently.