Supreme Court of Canada rejects Paletta, grants Iristel appeal in tax cases
Forex trading, carousel schemes, court jurisdiction and retroactive tax planning
TORONTO, April 2, 2023 – Earlier this month, the Supreme Court of Canada announced whether it would hear appeals in three high-profile tax cases, including one involving forex trading losses and another on the jurisdiction of the Tax Court of Canada.
The former case brings to an end years of litigation involving a wealthy family of real estate developers in Burlington, Ontario. The latter a “fiery” and “heated” case over what, if any, court has authority and jurisdiction to review the conduct of the Minister of National Revenue.
Forex trading scheme netted falling Leafs in tax avoidance scheme
The decision by the Supreme Court of Canada to dismiss, with costs, an application by the estate of the late Pasquale (“Pat”) Paletta, brings to an end a dispute that dates back more than 20 years. As reported by the Toronto Star, more than 150 taxpayers were reassessed by the Canada Revenue Agency over their participation in a foreign exchange (forex) market tax scheme, including former members of the Toronto Maple Leafs.
The case involved many strange turns. Almost all of the income generated by the taxpayer over a period of several years was offset by forex losses. The CRA denied the trading losses, issued reassessments and applied gross negligence penalties. The taxpayer took the CRA to the Tax Court of Canada and was represented by Canadian tax litigators from KPMG Law.
The CRA alleged that forex trading was conducted to artificially create tax losses—there was no real “trading” (in the way that most investors consider trading) taking place. To the courts, the main issue was whether a commercial activity that was undertaken solely to generate tax losses could be considered as a source of income or loss for tax purposes.
As reported in Canadian Accountant, the Paletta family were no strangers to Tax Court, having lost another tax avoidance case, this time involving the film industry. The presiding judge, David E. Spiro, had once worked in the tax litigation section of the Department of Justice and had represented the Crown before the Supreme Court in a case involving trading in gold futures.
In a lengthy decision, he allowed the Paletta appeal, ruling that the trading activities gave rise to a source of income in the form of a business, despite acknowledging that the trades were never made for profit, and almost exactly offset profits. The trades, in his opinion, carried some risk — the amount of which “matters not.”
Twists and turns before the case concludes
In a strange sidenote to the case, the justice was under review by the Canadian Judicial Council, for conduct unrelated to the case. As part of the process, Justice Spiro was supposed to recuse himself from hearing cases involving Muslim litigants or lawyers, a promise made by Tax Court Chief Justice Eugene Rossiter.
Yet legal observers noted that the Crown was represented in the Paletta case by two lawyers whose names — Rana El-Khoury and Dina Elleithy — fit the category for which Chief Justice Rossiter had vowed his court would be on the lookout, according to the Globe and Mail.
The Crown took the case to the Federal Court of Appeal, which ruled that, despite the appearances of commerciality, the activity was not (in the words of the Supreme Court) “in fact conducted with a view to profit, a business or property source of income could not be found to exist.”
The wording of its unanimous decision seemed particularly harsh: “The Tax Court’s reasons … are not only incorrect, they are implausible” and “The Crown has succeeded in demonstrating that Mr. Paletta was grossly negligent in portraying his trading losses as business losses even though they were not.”
Nevertheless, the Paletta estate appealed to the Supreme Court (a move predicted by Canadian Accountant in 2022), which dismissed the appeal with costs, reversing the decision by Justice Spiro, and finally closing the case.
Who supervises the Minister of National Revenue?
Unlike the Paletta case, the Supreme Court said it would hear the appeal of Iris Technologies (Iristel), albeit with another case, Dow Chemical Canada ULC v. His Majesty the King. The question in both cases is, what, if any, court has authority and jurisdiction to review the conduct of the Minister of National Revenue?
Iristel sued the CRA for $275-million over a sales tax battle in which the agency alleged the company had engaged in a tax avoidance “carousel scheme." The company countered that the CRA did not understand the wireless business and its decision to withhold tax refunds was hurting the company’s business.
In the Dow Chemical case, the Minister declined a request to reduce the amount of the company’s assessement, and Dow wanted to challenge the decision, but it was unclear whether the Tax Court or Federal Court had jurisdiction to do so. In the Iristel case, the courts have acknowledged that a clear dispute about refunds exists between the parties, but disagree as to whether the Court could compel the payment of refunds.
“The jurisdictional boundaries between the Tax Court of Canada and Federal Court over taxation matters has often been a trap for taxpayers,” writes Alexei Paish of Thorsteinssons LLP. Iristel sought an order to compel the Minister to release millions of dollars in refunds. The CRA contended that the matter should be dismissed because the issues Iristel is raising are moot; the Court ruled against the CRA and the the case proceeded to the Federal Court of Appeal, which granted the Minister’s motion to dismiss the appeal.
“Selecting the appropriate jurisdiction is an important first step in all tax litigation,” writes Paish. “Iris Technologies confirms that jurisdictional matters must be considered throughout the course of the litigation process to ensure a timely and proper resolution.”
Retroactive tax planning never saintly
Finally, a case of three strikes and you’re out, for the St. Benedict Catholic Secondary School Trust. The trust had a leasehold interest in a school property and claimed certain amounts as capital cost allowance (CCA) in filing its tax returns over a number of years. The CRA reassessed the Trust’s tax liability and denied the non-capital loss claim because the time period within which the losses could be carried forward had expired.
The Trust did not challenge the CRA’s claim that the NCLs had expired, but instead raised the argument that it had realized a terminal loss in 2017 when it disposed of its leasehold interest. The Trust lost its case before the Tax Court of Canada, then the Federal Court of Appeal, which said the Trust was trying to amend its prior years’ returns, and the Supreme Court dismissed its leave to appeal.
In the words of HKL Tax Law:
Thus, the Trust had a choice to make when it filed its tax returns for 1997 to 2003: claim CCA in order to generate NCLs to use in future years, knowing that those NCLs may expire, or not claim CCA and potentially have less NCLs to use, although a higher undepreciated capital cost (“UCC”) balance that does not expire. The Trust made its decision and the FCA held it to its decision.
Or, in the words of Marcil Lavallée: “Usually, the CRA allows changes to past returns if a deduction has been overlooked. However, the CRA will deny requests to change past CCA claims, if the purpose is considered to be “retroactive tax planning”, because you have later determined that you did or didn’t want to claim CCA in a particular year.”
The decision by the FCA may have broader implications, according to tax professionals, as the CRA, which may have been more lenient in the past, cannot change a taxpayer’s decision to make an election.
By Canadian Accountant staff.