Rules regarding cost awards and settlement offers are important tools to promote settlement in the context of general civil litigation and are generally seen as an important tool to minimize use of scarce court resources. 

In tax cases, settlement offers have historically tended not to play as important a role, which is perhaps attributable to the fact that tax appeal outcomes tend to be mostly binary in nature (i.e. a complete success or complete failure).  This differs markedly from most other civil litigation where the quantum of damages is often the central contested issue.  Furthermore, Canada’s Tax Court Rules have historically only considered settlement offers as one of many factors to be considered when making a costs award, without setting out more definite implications of settlement offers for awarding costs.

This may be changing under new Tax Court Rules 147(3.1) and (3.2) which grant a party “substantial indemnity” costs after the date of its offer to settle (defined to be 80% of solicitor and client costs in Rule 147(3.5)), if judgment is as or more favourable than the offer. 

Although these rules have recently operated in favour of successful appellant taxpayers (see for example: Sunlife (2015 TCC 171) and Repsol Canada Ltd. (2015 TCC 154))  the TCC’s cost award in Standard Life (2015 TCC 138) serves as a warning to taxpayers that they may be liable for significant costs, where a settlement offer from the Crown has been rejected.

In Standard Life, the key issue was whether the Minister correctly reduced the Appellant’s cost base on certain property on the basis that the Appellant was not entitled to a bump in its cost base due to the inapplicability of subsection 138(11.3) of the ITA (a specialized rule applicable to life insurers).  The Crown made a settlement offer accepting that the Appellant did not carry on business in Bermuda in 2006 and acknowledged that it did carry on business there in 2007.  The Appellant did not accept this offer and the TCC ultimately agreed with the Crown that the Appellant did not carry on business in Bermuda in either 2006 or 2007.  The Crown claimed costs pursuant to Rule 147(3.2), arguing that it had beat its settlement offer at trial.

The TCC agreed, and awarded costs in line with Rule 147(3.2) – specifically, a lump sum award of $474,663.  The TCC held that the settlement offer contained an element of compromise as discussed in McKenzie (2012 TCC 329).  In McKenzie, the TCC held that an offer by an appellant to have its appeal allowed in full but to not seek legal costs, did not contain a sufficient degree of compromise to be considered in awarding costs pursuant to Rule 147(3.1) (although the Rule was not yet effective at the time of the case, a TCC Practice Note provided that the TCC shall conform to the proposed Rule).  Here, the TCC noted that the Crown’s settlement offer would have resulted in significant tax savings to the Appellant by allowing it to reap the benefits of section 138(11.3) one year earlier.  

Furthermore, the TCC noted that an analysis of the enumerated factors in Rule 147(3) supported an award for increased costs to the Crown: the Crown was 100% successful on all issues; the amounts at issue were extremely large; the issues were of widespread importance; the significant volume of work by the Crown (in part, caused by the fact that it was required to call more witnesses and fill in factual blanks that the Appellant itself failed to do); and the complexity of the special rules pertaining to multinational insurers.  The TCC also awarded expert fees the Crown incurred for hiring an insurance industry actuarial expert; despite the fact that the expert was not called at trial and did not prepare an expert report for use at trial.

By way of commentary, the Standard Life case serves as a cautionary tale for taxpayers proceeding on less than clear cases, since there is legitimate risk for significant costs liabilities.   The decision was consistent with Rule 147(3.2) as well as with the cost awards issued in Sunlife and Repsol Canada Ltd, and in principle, there is no reason that these cost awards cannot be used against taxpayers, in appropriate cases.   That said, a strict application of Rule 147(3.2) is not necessarily appropriate in all circumstances as it may unduly discourage taxpayers from proceeding on legitimate “test cases”, or deprive taxpayers with scarce financial resources from access to justice.

In terms of what will constitute a valid settlement offer, the TCC’s review of the principle in McKenzie also provides some guidance as to what type of settlement offer will trigger Rules 147(3.1) or (3.2).  Given that the FCA has held that tax appeal settlements must be made on a “principled basis” (see: Galway, [1974] 1 FC 600 and CIBC World Markets Inc., 2012 FCA 3), it might be difficult for appellants to fashion “principled” offers that still constitute a “compromise”, in order to benefit from the application of Rule 147(3.1).  This is because of the aforementioned tendency for tax appeal outcomes to be binary in nature, such that any “principled” settlement offer would often, by definition, have to be for a complete allowance of (or dismissal of) the appeal.

Finally, and although there is no indication that the taxpayer in this case had entered into a contingency payment arrangement with its counsel, one of the most important things coming out of this case is the huge problem it presents for current and future contingency fee cases – as practitioners taking these cases forward will now presumably have to deal with the prospects of material cost awards against them if losing, and the requirement that they properly advise their clients of that risk before proceeding.

A previous version of this article was published in the December 2015 edition of Canadian Tax Highlights