Canada Revenue Agency Won’t Follow Court of Appeal on Change in Use Rules. Is This Right?

Published by Thorsteinssons LLP

Suppose you disagree with a CRA assessment and appeal the issue to the Tax Court. Suppose you lose the case. And suppose you decide the court is wrong in its reasoning and file your next tax return on the basis that your interpretation of the law is the correct one, what would you expect the CRA to do with your return? Exactly: a reassessment disallowing your position.

Now suppose that the decision went the other way and it’s the CRA who lost. Like you, the CRA believes the court got it wrong and that its position is correct. It publishes a technical interpretation to this effect. What happens now? In a nutshell, this is what’s happened following the decision last year in the Federal Court of Appeal in the CAE Inc. v The Queen case.

One of the issues considered by the court was the proper application of the change in use rules in subsections 45(1) and 13(7) of the Income Tax Act. Very generally, those rules provide that when property that has been acquired for an income earning purpose is used for some other purpose (and vice versa), then there is a deemed disposition of that property at its fair market value. If the property has appreciated in value, there will be an income inclusion and additional tax to be paid even though there is no actual sale and no receipt of any sale proceeds with which to pay the tax. Until the CAE case, the CRA’s administrative position was to limit the application of these rules to cases in which the use of the property changed in whole or in part from a personal use to an income producing use, or vice versa. Importantly, the rules were not applied when property was converted from inventory to an income earning capital use, and vice versa. (See Interpretation Bulletins IT-102R2 and IT- 218R.)

Frankly, the CRA’s administrative position here made a lot of sense. As long as the property continued to be used for income earning purposes, it was not essential to treat the change as a realization event. Certainly this was so for taxpayers, since it avoided what otherwise might have been a difficult valuation exercise. And the CRA benefited too in that enforcing a change in use disposition could raise significant compliance and administrative burdens. But the FCA says the CRA was wrong in interpreting the Act this way, so what should the CRA do?

The answer from the CRA is that they do not agree with the FCA’s analysis. In its view, it leads to an untenable result, one that does not accord with the object, spirit, and context of the provisions in question. (This is a précis of the CRA’s position as set out in recently published Technical Interpretation,  2013-0493811C6, issued in response to a question put to it at the 2013 Annual Conference of the Canadian Tax Foundation.)  Accordingly, the Agency will continue to apply the change in use rules in accordance with its established administrative practice, notwithstanding the FCA’s decision. What’s going on here? Is the Agency entitled to disregard a decision of the FCA that it thinks is wrong? Taxpayers don’t have this luxury.

In fairness to the CRA, it acknowledges the difficulty here. It can’t just ignore the decision as if it didn’t happen. To side step the issue, it takes the position that the FCA’s comments on the change in use point were obiter dicta – that’s lawyer speak for comments that are not binding because they are not essential to the court’s main conclusion. However, it is not at all clear to me that the comments are obiter. And even if they are obiter, the court deals with the interpretation of the change of use rules at some length, in response to submissions it expressly requested from counsel for both sides. So it’s hard to dismiss the remarks as unimportant.

That being said, as I have indicated, it seems to me that the CRA’s analysis makes a lot more sense than the one developed by the court. So here’s the dilemma. Should we cut the CRA some slack here and ignore the fact that they are disregarding a specific finding of the Court of Appeal, on the basis that it seems to make sense to do so? Does it matter that we are saying that it’s OK for the CRA to ignore the law established in a decision if it thinks the result of that decision is wrong? Is the CRA above the law? I’m not at all comfortable with the CRA’s response in this case. As a professional tax advisor, it puts me in a difficult position. The CRA’s position makes sense, but I have doubts that it is still correct in view of the court case. Can I advise my clients to rely on the Agency’s published position? Not without some reservations. It’s apparent from other cases that the Agency feels free to disregard its administrative practices when it wants to. So I’m between a rock and a hard place in counseling clients on what to expect here.

Could the Agency have approached the matter differently and reached the same result without appearing to put itself above the law? I think so. Instead of saying that the Court of Appeal had misinterpreted the law, the Agency could have published a note saying that it was concerned about the implications of the court’s decision on the change in use rules. It could have said that it was asking the Department of Finance to propose a clarifying amendment to the Act confirming its administrative practice. In the meantime, it could add, it would continue to administer the provisions on the old basis on the assumption that the clarifying amendment would have retroactive effect to the date of the CAE Inc. judgment. By doing so, the Agency would affirm that it respected the decisions of the courts, while achieving the desirable result of continuing its preferred administrative practice. It’s disturbing that the CRA approached the matter the way that it did. Like us taxpayers, it’s subject to the law even when it may not like it.