In Milgram Foundation v. Canada (Attorney General) (2024 FC 1405), the Federal Court of Canada held that the decision of the Canada Revenue Agency (CRA) to reassess after accepting the taxpayer’s voluntary disclosure was an “abuse of power” and violated principles of consistency, finality and the integrity of the law. In a striking rebuke of the CRA’s audit conduct in a situation that offended basic principles of fairness in the Canadian tax system, the Federal Court quashed the CRA’s decision to reassess and ordered it to take such actions as are necessary to give effect to a reconsidered decision.
Facts
The Milgram Foundation (the Foundation) was established as an “Anstalt” under the laws of Liechtenstein in 1964, and in 1983 it became a “Stiftung”, which is generally considered to be a personal trust under Canadian law. At all relevant times, the Foundation was managed by an independent Foundation Council, the members of which were all non-residents of Canada. It was factually non-resident in Canada for tax purposes and therefore did not file Canadian income tax returns, even though it had Canadian beneficiaries.
In 2013, the Foundation determined that it may be deemed resident in Canada under section 94 of the Income Tax Act, and thus required to file tax returns in Canada. It therefore spent the next two years gathering available records and sufficient information to make an application under Canada’s voluntary disclosure program (VDP) for the 2003 to 2014 tax years. The VDP application was filed in January 2015, and accepted by the CRA as valid and complete in December 2015, but the CRA reserved the right to audit or verify those years. Accordingly, in January 2016 the CRA issued Notices of Assessment for 2003-2014, and the Foundation paid outstanding taxes and interest owing of C$9.4 million.
In July 2016, the CRA initiated an audit, which ultimately detected no errors or omissions for the 2003-2014 tax years under the disclosure. However, upon completion of this lengthy second audit in September 2018, the CRA alleged the Foundation had undisclosed investments and the CRA intended to reassess the Foundation’s 1998-2002 tax years on the basis that the Foundation had omitted certain investment account information, such omission allowed for reassessment of these old tax years, and the Foundation had been established in 1964.
The Foundation made an application to the Federal Court for judicial review of the CRA’s decision to reassess the 1998-2002 tax years on the basis the CRA’s decision breached the Foundation’s legitimate expectations, was an abuse of process, and was unreasonable. Meanwhile, in 2021, the CRA unilaterally issued Notices of Assessment for the 1998-2002 tax years.
The Federal Court agreed with the Foundation, declaring that the CRA’s decision to reassess the earlier tax years was an abuse of process. The Federal Court quashed the CRA’s decision and sent the matter back to the CRA to “take such actions as are necessary to give effect to the reconsidered decision”.
In its reasoning, the Federal Court determined that the Foundation was seeking to challenge the CRA’s conduct rather than the assessments themselves. The Federal Court held that the Foundation was not making a collateral attack on the assessments, but rather had properly raised allegations of unfairness and abuse of process against the CRA, and accordingly this was properly within the jurisdiction of the Federal Court to adjudicate. Thus, the Foundation was not precluded from seeking declaratory relief on the basis of the Supreme Court of Canada’s recent decision on judicial reviews in tax in the cases of Dow Chemical (2024 SCC 23) and Iris Technologies (2024 SCC 24).
While the Federal Court held that the CRA’s acceptance of the Foundation’s voluntary disclosure did not create a binding contract between the two parties, the Court held that the CRA’s decision to reassess the earlier tax years was “devoid of any justification” and thus was an “abuse of power”. The Crown has appealed the decision to the Federal Court of Appeal (Court File No. A323-24).
Analysis
The Milgram Foundation case raises a number of complex issues regarding tax compliance, the voluntary disclosure process, and the jurisdictions of the Tax Court and Federal Court.
The Foundation was not formed as a trust in Canada, but rather as a foreign entity that is generally recognized as a trust for the purposes of the Income Tax Act in Canada. Normally, the residency of a trust under Canadian law is its place of central management and control. For the Foundation, this was clearly outside of Canada. However, section 94 of the Income Tax Act may “deem” a trust to be resident in Canada in certain circumstances, and this deeming rule overrides any contrary terms in any of Canada’s bilateral tax treaties. Given that there were Canadian resident beneficiaries here (and other provisions under section 94 apparently applied), the Foundation was required to report its income in Canada. This was belatedly completed in the VDP request.
The purpose of the VDP is to address tax non-compliance by allowing taxpayers to voluntary correct historical errors and omissions in their tax filings in exchange for potential relief from interest/penalties and protection from criminal prosecution. The VDP was significantly overhauled in 2018 to impose new conditions and narrow the relief available, and to create two new separate tracks: the General Program (which permits penalty relief and partial interest relief) and the Limited Program (which permits waiver of gross negligence penalties, but not interest or other penalties). The Limited Program applies where there is an element of intentional conduct by the taxpayer or a related party. The CRA decides which track the taxpayer will be eligible for, but this decision is not normally conveyed to the taxpayer until after the application is made.
In this case, the Foundation made its VDP application in 2015, under the previous, more liberal program. In the Federal Court application, the Foundation submitted the affidavits of seven tax professionals who had represented clients on VDP applications over several years. All stated that, in their experience, the CRA’s acceptance of a VDP application settles all past omissions disclosed to the CRA. This would include years for which records were no longer available due to the passage of time. It was broadly understood that, administratively, the CRA accepted that very old tax years may simply have no reliable records in existence. Thus, it was not possible or fair to assess ancient tax years for accidental non-compliance.
This is an important point in the Milgram Foundation case. The successful administration of the VDP requires the good faith participation of both sides — taxpayers and the CRA. Taxpayers’ disclosures are required to be accurate and complete. The CRA must receive and assess this voluntarily disclosed non-compliance in a fair manner because the existence of such program incentivizes and induces non-compliant taxpayers to voluntarily disclose. Deceit, opaqueness, retractions and double-crosses — on either side — are the enemies of a well-functioning voluntary disclosure process.
But in Milgram Foundation the existence of both the letter which proposed to assess the Foundation’s 1998-2002 tax years after the VDP process was completed — which was the “decision” that was being reviewed by the Federal Court — and actual assessments for those years creates an unusual uncertainty in this case. The Supreme Court of Canada has noted that the CRA is never beyond reproach and its conduct may be reviewed. But since the Federal Court has limited or no power to prevent the CRA from issuing an assessment, nor any power to overturn or vacate an existing assessment, the only relief a taxpayer may obtain vis-à-vis an assessment would be via the objection and appeal procedures in the Income Tax Act or the Excise Tax Act.
To that end, the Federal Court’s declaration in Milgram Foundation that (i) the CRA’s decision to reassess was an abuse of process, and (ii) the CRA was “to consider the Court’s declaration and to take such action as are necessary to give effect to the reconsidered decision” is unusual. We may suppose that the Federal Court issued such declaratory relief on the anticipated basis that the CRA will cancel the existing assessments, and having done so may reconsider the original decision to reassess.
The Court may be expecting the CRA to take a dispassionate view of the potential assessments for the earlier years, and decide to assess (again) only if some fair and objective basis for assessing may exists. However, in our experience this process seems very unlike the CRA’s typical auditing and assessing processes. If the procedural aspects of implementation are unclear, it seems difficult to see the CRA giving the benefit of the doubt to the Foundation in this case.
Conclusion
Taxpayers challenging the conduct of the CRA in judicial review applications face an uphill battle. The courts have given the CRA significant latitude to choose whether, when, and how audits and assessments may be undertaken, conducted and issued.
However, in Milgram Foundation the Federal Court clearly identified the unfair and abusive conduct of the CRA. The case provides a helpful illustration of the court’s view of the limits on acceptable audit conduct. But the unpredictability created by the CRA’s unusual decision to add five tax years to an already-complete and valid disclosure could have the effect of introducing unacceptable uncertainty to the VDP process. A taxpayer’s efforts towards good faith compliance should be met in return by good faith of the CRA.
One may expect a challenge of the decision based on the jurisdictional issue raised, although the CRA may still decide, after further review of the Foundation’s 1998-2002 tax years, to issue Notices of Assessment. And while the Federal Court remains, for now, an important backstop for reviewing and sanctioning improper CRA conduct, the nuances and limits on the Federal Court’s power to provide relief has given us no clear answers as to how we can sort out situations in which abusive conduct led to the issuance of tax assessments.