Tax Disputes With The Canada Revenue Agency (CRA) – The Burden Of Proof
Many taxpayers respond to a reassessment by the Canada Revenue Agency by saying, “prove it”. This response is usually based on an understanding that in our justice system a person is innocent until proven guilty.
Unfortunately tax law does not operate on this same principle. In fact it is just the opposite. In a tax dispute, the burden of proof is on the taxpayer to prove that the CRA’s assessment of tax liability is wrong.
The basic rationale for placing the initial burden of proof on the taxpayer is that the information required to determine the proper tax liability of the taxpayer is in the possession of the taxpayer and not the CRA. This rationale is supported by subsection 152(8) of the Income Tax Act (Canada) which deems an assessment to be valid and binding until it is vacated or varied on objection or appeal.
Placing the initial burden of proof on the taxpayer means that it is critically important that proper documentation and credible evidence is produced in support of the taxpayer’s position.
Assumptions and Canada’s Tax Dispute Process
The tax system in Canada is a self-reporting system. This means that taxpayers report their income annually on their tax returns. The CRA then assesses based on that information.
The tax dispute process typically begins where the CRA conducts an audit or investigation process which can result in a reassessment of the taxpayer. The taxpayer is given 90 days to object to such a reassessment.
This objection is sent to and processed by the appeals division of the CRA. The appeals division considers such an objection and reviews the information provided by the taxpayer and the auditor. The appeals officer decides whether to vacate the reassessment, vary the reassessment or confirm the reassessment.
In making the reassessment the auditor makes assumptions regarding the tax liability of the taxpayer. The appeals officer may make further assumptions in processing the objection and deciding whether to vacate, vary or confirm the reassessment.
These assumptions play a very important role in the tax dispute process. The assumptions are presumed to be true until the taxpayer discharges the initial burden of proof.
Where the appeals officer decides to confirm the reassessment or varies the reassessment in a manner with which the taxpayer disagrees, the taxpayer has the opportunity to appeal to the Tax Court of Canada. The taxpayer has 90 days to file a Notice of Appeal with the Tax Court of Canada registry.
Discharging the Initial Burden of Proof: Demolishing the Assumptions
At the Tax Court of Canada, the taxpayer bears the initial burden of proof to “demolish” the CRA’s assumptions. The CRA’s assumptions must be included in the pleadings filed on behalf of the CRA and must be complete, precise, accurate and honestly and truthfully stated so that the taxpayer knows exactly the case and the burden that he or she has to meet.
The word “demolish” has been regularly used by the Tax Court of Canada, Federal Court of Appeal and Supreme Court of Canada to describe what a taxpayer must do to discharge its initial burden of proof. However, the use of the word “demolish” can be somewhat misleading. The Canadian courts have established that in order to “demolish” or overcome the CRA’s assumptions, the taxpayer must adduce evidence that makes out at least a prima facie case. Prima facie is a latin phrase that means “at first sight” or “on its face”.
There are three approaches that a taxpayer can take in establishing a prima facie case in order to demolish the CRA’s assumptions. The taxpayer can:
- discharge the burden of proof by showing that one or more of the assumptions were wrong;
- demonstrate that even if the assumptions are true, they do not support the assessment of tax liability that is contended by the CRA; or
- establish that when assessing the taxpayer, the CRA auditor and appeals officer did not in fact make the assumptions that are pleaded.
If the taxpayer establishes a prima facie case, thereby demolishing the CRA’s assumptions, the burden of proof shifts back to the CRA to prove the assumptions. At this stage, the CRA must present something more concrete than simple assumptions. The CRA must adduce evidence that provides a foundation for the assumptions. If the taxpayer demolishes the CRA’s assumptions and no further evidence is adduced by the CRA, then the taxpayer’s appeal should be successful. If further evidence is adduced by the CRA, then the judge must decide, on a balance of probabilities, who is correct: the taxpayer or the CRA.
There are some exceptions to the general rule that the taxpayer bears the initial burden of proof. For example, the CRA bears the initial burden of proof when:
- assessing gross negligence penalties under 163(2);
- assessing a taxpayer pursuant to the General Anti-Avoidance Rule (GAAR); and
- establishing that it is appropriate to assess a taxpayer beyond the normal three or four year limitation period.
Additionally, if a fact is not something that is within the taxpayer’s knowledge, the rationale for placing the initial burden of proof on the taxpayer does not apply, and the taxpayer can argue that the initial burden of proof should be placed on the CRA.
- if an assumption, although pleaded, was not actually made by the auditor or appeals officer in assessing the taxpayer, then the initial burden of proof does not fall on the taxpayer; and
- if an assumption, although made by the auditor or appeals officer, was not included in the pleadings filed on behalf of the CRA, then the initial burden of proof does not fall on the taxpayer.
Understanding the central role of assumptions in a tax dispute with the CRA is critical to a taxpayer’s success. Generally, the taxpayer bears the burden of proof to “demolish” the CRA’s assumptions.
These concepts and principles are very unique to tax litigation.
It is not enough for a taxpayer to say “prove it”. This underscores the importance of maintaining proper documentation and compiling convincing and credible evidence when engaged in any tax dispute with the CRA.