Federal Court Of Appeal Strikes Out A Pleading Alleging That Expenses Are Non-Deductible In Light Of “Egregious And Repulsive” Conduct By A Taxpayer

by Dentons
Contact

Originally Published in International Tax Review - May 10, 2013.

In a ruling handed down May 6, 2013, the Federal Court of Appeal ordered that portions of a Crown pleading be struck out for suggesting that a deduction may be disallowed on the basis that the conduct of the taxpayer in incurring the expense was “egregious or repulsive”.  Sharlow J. A. wrote the reasons in Canadian Imperial Bank of Commerce v. The Queen, 2013 FCA 122 in which Evans J.A. and Stratas J.A. concurred.

By way of background, the Canada Revenue Agency reassessed CIBC to disallow the deduction of some $3 billion of expenses incurred between 2002 and 2006.  The expenses at issue were incurred to settle litigation in the United States arising from losses suffered due to the collapse of Enron Corporation.  In the U.S. litigation, it was alleged that CIBC participated in the financing of Enron in a manner that made it liable to the complainants.

The Income Tax Act provides the formula for determining a taxpayer’s income for the year for income tax purposes.  Under paragraph 3(a), one component of a taxpayer’s income is income from a business of the taxpayer.  Under subsection 9(1), a taxpayer’s income for a year from a business is the taxpayer’s profit for the year from that business. 

The most important limitation on the scope of subsection 9(1) is paragraph 18(1)(a) which provides:

18. (1) In computing the income of a taxpayer from a business […] no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business […];

In 65302 British Columbia Limited v. The Queen, a 1999 decision in which the deduction of a fine was allowed (later to be specifically disallowed by Parliament), Iacobucci J. of the Supreme Court of Canada made the following observation:

It is conceivable that a breach [of the law] could be so egregious or repulsive that the fine subsequently imposed could not be justified as being incurred for the purpose of producing income.

In the contentious part of its pleading, the Crown relied on that obiter statement and offered the following theory of non-deductibility of expenses:

134. The misconduct of [CIBC and its affiliates] was so egregious and repulsive that any consequential settlement payments […] cannot be justified as being incurred for the purpose of gaining or producing income from a business or property within the meaning of paragraph 18(1)(a) of the [Income Tax] Act. The [CIBC affiliates] knowingly aided and abetted Enron to violate the United States’ federal securities laws and falsify its financial statements. The misconduct of [the CIBC affiliates] in enabling Enron to perpetrate its frauds, known to [CIBC], or the misconduct of [CIBC] itself, was so extreme, and the consequences so dire, that it could not be part of the business of a bank.

The Crown’s contention, in a nutshell, was that an expense incurred due to conduct of the taxpayer that was “egregious or repulsive”, is precluded from deduction by paragraph 18(1)(a) of the Income Tax Act.

The CIBC asked the Tax Court of Canada to strike out that paragraph along with the other portions of the pleading reflecting the same theory.  The Tax Court chose not to do so.  The Federal Court of Appeal disagreed and struck out the contentious paragraph along with the related parts.

In dismissing the Crown’s argument, the Federal Court of Appeal emphasized that “the only question to be asked in determining whether paragraph 18(1)(a) prohibits a particular deduction is this: Did the taxpayer incur the expense for the purpose of earning income?”  The Court concluded by stating that the characterization of the morality of a taxpayer’s conduct is not legally relevant to the application of paragraph 18(1)(a) of the Income Tax Act.

Parties are generally given the opportunity to make whatever arguments they consider necessary to their case with the ultimate determination being made by the trial judge who is in the best position to decide questions of relevance and weight in light of all the evidence.  It is rather unusual for a legal theory, novel though it is, to be taken off the table at such an early stage.  At the same time, courts are increasingly concerned about “proportionality” and are reluctant to allow scarce judicial resources to be spent on matters that are unlikely to have any effect on the outcome of the hearing.  Whatever one’s view of the matter the Crown rarely seeks leave to appeal on procedural points, making it unlikely that this decision will be reviewed by the Supreme Court of Canada.

Notwithstanding the decision of the Federal Court of Appeal, the Crown will still be able to argue that the deductions taken by CIBC ought to be disallowed on a variety of other grounds including:

  • the deduction of the settlement payments does not accord with well accepted business principles;
  • the settlement payments were not made for the purpose of earning income from a business;
  • the settlement payments were outlays on account of capital;
  • the settlement payments were contingent liabilities when made; and
  • the amount of the settlement payments were not reasonable in the circumstances. 

Although the taxpayer has prevailed in this battle, the war has just begun.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Dentons | Attorney Advertising

Written by:

Dentons
Contact
more
less

Dentons on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!