Taxpayers carrying back losses to offset tax liabilities of prior years may, in certain circumstances, find themselves subject to interest accruing far longer than expected. The outcome of the case, now before the Supreme Court of Canada, could have wide-reaching implications for audit-affected taxpayers looking to carry back losses following the conclusion of their audit.
Imagine you join a friend’s pre-booked taxi ride. You benefit from the trip, but you didn’t cause the taxi to be ordered—it would have run with or without you. In most situations, the idea that you owe fare to the taxi would seem absurd.
Now replace the taxi company with the Canada Revenue Agency (CRA) and the absurdity of the outcome becomes reality.
The CRA successfully argued a similar point in a recent Federal Court of Appeal decision, with a very costly result: the taxpayer’s tax liability had several extra years of arrears interest added to it.
The case is a cautionary tale. Taxpayers who carry back losses to offset prior-year taxes may, in certain circumstances, face interest accruing far longer than anticipated.
With the Supreme Court of Canada set to weigh in, the decision could have significant implications for taxpayers emerging from audits who plan to carry back losses after the fact.
The central issue in Bank of Nova Scotia v. The King was whether the taxpayer (the bank) would be subject to interest on tax liability from the reassessed year (2006) until the filing of the tax return for the year the bank incurred the carried-back losses (2009) or until the bank made a carryback request (2015).
The bank had held off on making a loss carryback request until the audit concluded and an upward adjustment was made to its taxable income.
The Income Tax Act normally imposes interest on unpaid tax from the day the tax payment is due. When a loss carryback is subsequently used to reduce the tax payable of a prior year, paragraph 161(7)(b) of the Income Tax Act determines how that loss carryback impacts the calculation of interest.
Under para. 161(7)(b), interest continues to accrue until 30 days after the latest of certain events, including:
In the Bank of Nova Scotia v. The King, the bank underwent a transfer pricing audit for its 2006 taxation year, which concluded in 2015 with a reassessment that substantially increased the bank’s taxable income and taxes for 2006.
Following the audit’s conclusion in 2015, the bank requested its 2008 losses be carried back to its 2006 taxation year. The CRA maintained that interest on the 2006 tax liability accrued not until 2009—the year the bank filed its 2008 tax return—but until 2015, the year of the carryback request. This effectively added six extra years of interest to the bank’s debt.
The interest timeline is based on the wording of the legislation, which requires determining whether the taxpayer’s written carryback request caused the 2015 reassessment or whether the reassessment resulted from the audit adjustment.
The bank argued the reassessment was issued as a result of the audit, whereas the carryback figures within the reassessment were merely incorporated as a formality. Therefore, it argued the interest should run until 2009.
The CRA viewed the reassessment as being caused by the carryback request, which meant interest ran until 2015.
The bank lost at the Tax Court of Canada and appealed to the Federal Court of Appeal (FCA).
At the FCA, the bank argued that the reassessment was pre-planned due to the audit and therefore would have occurred regardless of the bank’s carryback request. It further argued the CRA had no real discretion in responding to the carryback request in light of the planned reassessment and therefore could not approve the bank’s request.
The bank argued the CRA lacked discretion because the pre-planned reassessment would become inaccurate if the carried-back losses were not incorporated into the reassessment. As a result, the CRA’s discretion vis-à-vis the loss carryback was fettered, making the written request event mentioned above impossible to trigger.
Now, let’s return to the taxi analogy: the CRA issued a reassessment in order to make an audit adjustment, but the bank’s carryback request went along for the proverbial ride by being incorporated into the reassessment. Now, the CRA is asking the bank to pay for ordering the taxi, thereby treating the reassessment as if it was ordered by the carryback request instead of the audit.
The FCA rejected the bank’s argument and found instead that the reassessment was made “as a consequence” of the carryback request. The reassessment was caused by the taxpayer’s request, even though the reassessment also included an audit adjustment. Therefore, the provision’s causal element was satisfied.
The court held the CRA retained the discretion to accept or reject the carryback request. Even in the context of an audit adjustment being made, the production of the reassessment meant the CRA exercised its discretion in responding to the bank’s request, which satisfied the written request event and extended the time over which interest accrued.
In response to the bank’s argument about such a reading being unfair to taxpayers, the FCA noted that it should be assumed that Parliament had anticipated the outcome of a carryback request being delayed due to an audit and would have written the provision differently if it felt the added interest was onerous. The bank was granted leave to appeal to the Supreme Court of Canada. Oral arguments are expected to be heard sometime in 2026.
The FCA’s decision illustrates a rigid application of the Income Tax Act, reinforcing the need for early and explicit carryback requests where possible.
Even if the loss was incurred years before the formal request was made, interest may continue accruing until 30 days after a formal carryback request. This particularly affects taxpayers under audit who wish to carry back losses after the audit’s conclusion.
One option could be to request the carryback prior to the audit’s conclusion. However, this strategy shows the taxpayer as hedging their bets, potentially weakening their audit position. It would also be premature, as the audit may settle without an upward adjustment. Strategic decisions need to be made in the context of the individual dispute.
Timely updates and analysis of changing federal, state and international tax policy and regulation.
Stay updated on tax planning and regulatory topics that affect you and your business.
Experienced tax professionals track regulations, policies and legislation to help translate changes.
