Five important considerations in settling tax litigation

Settlements are an integral part of a tax litigation practice. Thousands of tax appeals are filed every year with the Tax Court of Canada, the majority of which never make it to trial. This is because most tax appeals are settled.

Litigation can be time consuming, stressful, and costly, and tax litigation is no exception. Given this reality, taxpayers are well advised to consider settlement at all stages of a dispute. Settlements are encouraged by the Tax Court, and can be beneficial not only for the taxpayer but also for the government and the Tax Court itself.^[1] Here are five important considerations in settling a tax dispute.

1. Settlements must be "principled"

In litigation between private parties, settlements are often reached on a compromise basis. For example, a defendant facing a claim for $100 might weigh its risk of losing at 20% and offer to settle for $20 based on the risk it perceives. Negotiations of the dollar amount between the parties might ensue and eventually a settlement reached where the dollar amount has no real tie to any claim. Rather, the settlement amount is simply the result of a compromise position taken by both parties based on an assessment of risk and cost of continuing the litigation. This type of horse-trading is not possible in a tax dispute.

In a tax appeal, the government, by law, can only settle on a principled basis.^[2] As a litigant in a tax appeal, the government's mandate is not to win at any cost, but rather to ensure that the law is correctly and fairly applied to all taxpayers. This means that settlements must be based on a result the Minister of National Revenue could have reached when initially assessing the taxes owing based on the facts and the law. An arbitrary percentage or amount based on risk and compromise is not allowed.

While this might seem like a highly limiting obstacle to settlement, in practice there are still many ways to reach principled settlements. For example, in a tax dispute based on the valuation of something, settlements are possible by arriving at a consensus on a value. However, there will be certain cases where settlements are an all-or-nothing situation, such as when the entire dispute turns on a question of pure law.

2. Settlement can occur at any stage

If a taxpayer has made their way to Tax Court, it is generally because the taxpayer was unable to resolve their tax dispute in the administrative process with the Canada Revenue Agency ("CRA") during audit or the CRA appeal process. This, however, does not mean that settlement can't occur early on in a tax case. Settlements can, and do, occur at all stages of a tax appeal. It is not uncommon for tax appeals to settle during pleadings, during or after discovery, or even on the "courthouse steps" just before or during a trial. It is important to keep the door to settlement open at all times, as an early settlement can be very cost effective for taxpayers.

To maximize the chance of an early settlement, it is important to keep in mind the government's perspective at the outset of an appeal. Tax disputes occur for many reasons, including, commonly, misunderstandings and miscommunications with the CRA, or insufficient evidence from the CRA's perspective regarding an issue. When the Department of Justice ("Justice") begins assessing a tax appeal, they do not have all the information the taxpayer has, but rather only have the CRA file embedded with the misunderstandings, miscommunications, or assessments they may contain. Early communications with Justice counsel, to explain and discuss the issues the taxpayer has with the assessment under appeal, can often lead to early resolutions, or at least narrowing of issues. For example, if a CRA assessment resulted from an alleged lack of documentation to prove a claim, and the taxpayer has since gathered the required documentation, there is little harm in sharing this documentation with Justice counsel early on in an appeal, even before discovery, to try and reach a settlement.

3. There are different options for documenting a settlement

If a taxpayer and the government reach a settlement, it will need to be documented and a process followed to end the appeal. There are different options to do this, and sometimes taxpayers and the government have different and opposing interests in this process.

Taxpayers may have an interest in keeping certain information on which a settlement is based confidential. Unsurprisingly, the government, in contrast, has a desire for transparency and can be criticized when settlements are kept confidential.^[3] Depending on the situation and importance of these considerations, there are different options to document a settlement.

A common option is a consent to judgement, which, generally, is the government's preferred option given its transparency. In this process, the parties' settlement terms are recorded in a document that is substantially in the form of a draft court order. This document is submitted to the Court on consent, such that the Court issues a judgement that reflects the agreed settlement terms (ending the appeal). Once the consent judgement is issued, it is treated the like a judgement from the Court had the matter gone to trial and been decided by a judge. The CRA would then issue a reassessment in accordance with the consent judgement.

One important consideration of a consent judgement is that the settlement needs to be limited to issues before the Court and within the Court's jurisdiction, otherwise the Court would not be able to issue the consent judgement. Practically, this comes up when a settlement covers multiple appeals or taxpayers, issues that are not before the Court (such as tax years still being assessed by the CRA), or issues such as interest and penalties which go beyond the Tax Court's jurisdiction. In these cases, a settlement agreement is needed (or a hybrid approach, using a settlement agreement and a consent to judgement).

Settlement agreements are another option for documenting a settlement with the government. Often referred to as "Minutes of Settlement", settlement agreements are effectively contracts between the parties that set out the terms of settlement. Settlement agreements do not involve the Court, and the parties have to agree to a process to end the appeal with the Court. This is often accomplished with the taxpayer discontinuing their appeal once the settlement agreement is signed, and/or the reassessment is made according to the terms of the settlement. A benefit of using a settlement agreement is that it can address things that a consent to judgement cannot, such as years that are not under appeal, which are outside the Court's jurisdiction. In addition, in certain cases, settlement agreements can include confidentiality obligations, if the parties agree to these.

4. Consider different settlement processes

Tax appeals can be settled informally between the parties (usually through discussions between counsel), or can be settled through other available dispute resolution processes. The Tax Court offers a few different dispute resolution processes that should be considered on a case-by-case basis.

The Tax Court offers a process to hold a "Settlement Conference". A Settlement Conference is an informal and non-binding discussion between the parties and a Tax Court judge. This process can be very effective, as it gives the parties the opportunity to see how a judge will view their case. There is no charge to the parties for holding a Settlement Conference, but certain conditions need to be met before the Court will schedule one. For example, the parties must exchange written offers beforehand and a representative with the authority to settle must be present for the entire conference.^[4]

The Court has recently introduced a "Fast-track Settlement Conference", a new variation of the Settlement Conference offered in response to delays caused by the Pandemic.^[5] It is unclear how much this new process is being used, but the process appears to be a streamlined version of a traditional Settlement Conference, with different pre-requisites and eligibility criteria.

Another mechanism that can be used to resolve some or all of a tax dispute is the Court's Preliminary Ruling Docket Procedure.^[6] This is a pilot program offered by the Court where a Tax Court Judge makes a non-binding preliminary ruling on an appeal. The preliminary ruling is based on an abridged hearing, which can last no more than two days, and there are various conditions (such as this process must occur before discovery) and criteria before the Court will agree to add an appeal to the preliminary docket pilot list.

The potential benefit of any of these options is often very case specific, but if an appeal is well suited for one of these processes, it can be very effective in resolving a tax dispute and minimizing litigation costs.

5. Be clear on what is being settled and the authority to settle

A couple of practical points to consider when discussing settlement are the scope of settlement and the authority to settle. These may seem like self-evident considerations, but can quickly become unclear when the parties have different perspectives or understandings.

Concerning the scope of settlement, it is important to remember that settlement usually only addresses the precise issues before the Court. An appeal in the Tax Court relates only to the specific assessments being appealed. For example, large companies might be under audit by the CRA for multiple years and multiple issues, only some of which are before the Tax Court, or a taxpayer may have a personal assessment that is under appeal in the Tax Court, but has a related business under audit by the CRA. In these situations, the taxpayers may have a more holistic view of their tax liability and approach settlement discussions from that holistic point of view. In contrast, the government, or even the taxpayer's counsel, may be approaching settlement discussions with a view of settling only the specific issue(s) before the Court. Further, other important considerations often take a back seat to the main tax liability issue when discussing settlement, such as litigation costs and the consequences of making and refusing settlement offers on possible future cost awards by the Tax Court. It is important that the scope of the settlement be clearly communicated and understood by all parties, including counsel and taxpayers themselves.

Similarly, it is important that the authority to settle be clearly communicated between all parties, as well as between taxpayers and their counsel. The law is generally clear that counsel has the authority to bind their clients to settlements. This is true for both taxpayers and the government.^[7] It is important that before concluding a settlement, the authority to settle has been properly granted, including clarity on the scope of a settlement.