When faced with Notices of Assessment from CRA that run contrary to a particular tax practice, taxpayers often defend their practice on the basis that CRA had not previously taken issue with it.  For tax litigators it is common to hear from clients: “CRA did not take issue with our tax compliance procedures in the past, so they should not be able to now!” 

Unfortunately, this argument will not be successful in the Tax Court of Canada, as was the case in the recent case of Academy of Applied Pharmaceutical Sciences (2014 TCC 171) – which reinforces that there is really no substitute for proper professional advice when determining GST/HST compliance.

The Academy of Applied Pharmaceutical Sciences (“Academy”) operated a post-graduate training college which offered two programs: (1) a Diploma Program on pharmaceutical science; and (2) a Workshop Program providing continuing pharmaceutical education.  The Workshop Program was subject to GST/HST, but the Diploma Program was GST/HST exempt.  Pursuant to section 169 of the ETA, the Academy was entitled to ITCs in respect of GST/HST paid on expenses related to its taxable supplies (i.e. the Workshop Program) but could not claim ITCs for GST/HST paid on expenses related to its exempt supplies (i.e. the Diploma Program).  For expenses that related to both programs (“mixed expenses”), the Academy was required to apply a “fair and reasonable” methodology for allocating such expenses to taxable and exempt supplies for purposes of claiming ITCs:  see subsection 141.01(5) of the ETA.

CRA conducted an audit of the Academy in 2008, and the CRA Auditor advised the Academy that a reasonable allocation ratio of the mixed expenses was 50% to taxable supplies and 50% to exempt supplies for the period being audited.  According to the Academy’s founder and director, the Auditor also advised that the Academy should use the same 50/50 allocation ratio going forward, which the Academy implemented.

Another CRA audit was conducted in 2012, in which the Academy was reassessed on the basis of an allocation ratio attributing only 14% of the mixed expenses to taxable supplies, thereby reducing the Academy’s ITCs (in turn, increasing its net tax payable).  The Academy appealed the assessment to the TCC.

In the TCC, the Academy (somewhat inexplicably) did not argue that its 50% allocation method was “fair and reasonable”, as is clearly required by subsection 141.01(5) ETA.  Rather, it argued that it would be unfair and inequitable for the Minister to be able to assess the Academy by applying a different ITC allocation ratio (i.e. 14%) after having previously advised the Academy to use a 50/50 ratio.  The TCC noted that the Academy was essentially relying on the doctrines of estoppel and officially induced error in doing so.

For the purposes of the decision, the TCC accepted the evidence that the CRA Auditor advised the Academy to use a 50/50 allocation ratio for its mixed expenses on a go-forward basis.  Nevertheless, the TCC rejected the Academy’s arguments and dismissed the appeal. 

The TCC ruled that neither the equitable doctrine of estoppel nor the doctrine of officially induced error are available as remedies in tax appeals.  It also noted that the proper apportionment of tax exempt earnings could easily be tracked in a given year, such that the Academy could have determined the appropriate allocation ratio and that the need for annual re-evaluation of the ratio was “self-evident”.

This decision serves as a reminder to taxpayers that CRA will not be bound by its previous representations and the only relevant issue on appeal of an assessment is compliance with the tax legislation.  It is also a reminder that professional tax advice should be obtained on an on-going basis to ensure compliance with the ETA (especially for those businesses engaged in making both taxable and exempt supplies).  Whether it is fair or not, the taxpayer cannot take solace in previous oversights, representations or recommendations made by CRA on previous audits.

This might have been a more interesting decision had the Academy argued that its 50% allocation ratio was fair and reasonable – not by virtue of the fact that the ratio was an accurate reflection of its mixed expenses used for taxable supplies – but by virtue of the fact that an allocation method that the CRA previously advised the Academy to use on a go-forward basis is inherently a “fair and reasonable” method for the taxpayer to employ.   

Further, there is a line of cases that does suggest that the CRA may be bound by estoppels of fact (e.g., where the CRA accepts one version of the facts, it cannot later suggest a different version of the facts), and it would have been interesting to explore whether the auditor’s conclusions on the 50% methodology might have been susceptible to characterization as an estoppel of fact – by which the CRA ought to have been bound.  Perhaps unlikely on the facts of this particular case, but something to keep in mind whenever dealing with estoppel arguments before the CRA.

A previous version of this article was published in the April 2016 edition of Tax for the Owner-Manager