Is the burden of proof in tax litigation always on the taxpayer?

November 10, 2022 | Marie-Hélène Tremblay

Burden of proof is a complex subject in Canadian tax litigation and has been heavily debated in recent years. While many mistakenly think the concept can be summarized by the often-heard phrase “the burden of proof in tax matters is on the taxpayer,” it is actually much more complicated and has many exceptions. While the general rule is that the factual assumptions made by the tax authorities in support of assessments are presumed to be valid[1] and the prima facie burden to “demolish” the assumption is on the taxpayer, some assumptions are not presumed valid: for example, factual assumptions that are not within the exclusive knowledge of the taxpayer. A recent interlocutory decision issued by the Tax Court of Canada (“TCC”) on February 22, 2022 in the case of Hong Kong Style Café Ltd.[2] directly addresses whether certain factual assumptions made by the tax authorities in support of assessments were deemed to be valid.

Hong Kong Style Café Ltd. decision

In this case, the tax authorities conducted a tax audit of two companies (Hong Kong Café Ltd. and Emerald Seafood Restaurant Ltd.) and one individual (Mr. Decade Chun Ping Or, a restaurateur). During the audit, the tax authorities used a sales estimation method based on an e-commerce audit algorithm. They concluded that the companies had used “zapping” software to delete transactions from their records. This of course would have resulted in under-reporting of sales (income tax) and associated sales tax. The CRA assessed consumption taxes on the allegedly unreported sales. The appellants, through their interlocutory motion, sought to strike out certain factual assumptions on which they claimed the assessments in dispute were based.

Appellants’ position

The appellants argued that the tax authorities’ evidence was based primarily on data from the use of the algorithm to estimate sales, and that it was the data from the algorithm that was the basis for certain factual assumptions supporting the assessments in dispute. According to the appellants, the facts arising from the use of the algorithm were exclusively within the tax authorities’ knowledge, and the appellants would have had to incur significant costs to disprove these assumptions. As such, the burden of proof with respect to these assumptions should be borne by the tax authorities.

Tax authorities’ position

The tax authorities argued that the factual assumptions challenged by the appellants did relate to facts that were exclusively within the taxpayer’s knowledge, and were not based on data derived from the algorithm. Rather, they were based on the appellants’ exclusive knowledge of whether or not they had deleted line items from their databases. As such, the appellants bear the burden of disproving the factual assumptions and should be able to prove their own revenue.

TCC decision

The TCC denied the appellants’ motion to strike out certain factual assumptions. The factual assumptions made by the tax authorities in this case were not based on the data derived from the algorithm. The burden of proof is therefore on the appellants to disprove the factual assumptions made by the tax authorities. The probative value of the data derived from the algorithm must be left to the discretion of the trial judge.

The Appellants are under no obligation to prove that the ECAS Algorithm is deficient or unreliable. Rather, their burden of proof will be discharged by disproving the Minister’s core assumed facts through the presentation of evidence at trial to substantiate, on balance, what were the correct sales, revenue and reportable income. (para 43)

Insights

While the Taxpayer was not successful in this motion, the case represents a very interesting analysis of the factual assumptions made by the tax authorities in support of an assessment. It is crucial to analyse in detail these assumptions to fully understand the burden of proof that relies on a taxpayer in a specific case.

If you are involved with a contentious or complex audit, or would like to dispute an assessment, the members of the Miller Thomson LLP Tax Dispute Resolution group are available to discuss your matter with you.

 

[1] This concept is based primarily on the courts’ interpretation of subs. 152(8) of the Income Tax Act (“ITA”) and para. 1, section 1014 of the Quebec Taxation Act (“TA”); St-Georges c. Québec, 2007 QCCA 1442.

[2] Hong Kong Style Café Ltd. et al. v. The Queen, 2022 TCC 9.

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