Ludco Enterprises Ltd./Les Entreprises Ludco Ltée, Brian Ludmer, David Ludmer, Cindy Ludmer v. Her Majesty the Queen, [1994] 1 CTC 368, 94 DTC 6143

Dubé, J.:— This is a motion to strike certain paragraphs from the statement of claim of the plaintiff ("Ludco") on the ground that these parts of the pleading disclose no reasonable cause of action (Rule 419(1)(a)), they are immaterial or redundant (419(1)(b)) and they may prejudice, embarrass or delay the fair trial of the action (419(1 )(d). This motion is directed against not only the Ludco statement of claim, but also those of the other plaintiffs, the three Ludmer children, so that this order will apply mutatis mutandis to the paragraphs in question of the four statements of claim.

During the period from 1977 to 1979, the plaintiffs purchased shares in overseas Companies. In order to do this, they borrowed money and paid interest. They also reported certain dividends, disposed of the shares in question and reported a capital gain. The plaintiffs claimed a deduction for the interest paid on the loans. By reassessments covering the 1981 to 1985 taxation years, the Minister of National Revenue ("the Minister") determined that this interest expense was not deductible within the meaning of paragraph 20(1 )(c) of the Canadian Income Tax Act in force at that time (R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act")), the relevant portion of which reads as follows:

20(1) Notwithstanding paragraphs 18(1 )(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be oeducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy). . . .

The reassessments in question were appealed to the Tax Court of Canada, which affirmed them. The four taxpayers then filed the present appeals to this Court.

In their statements of claim the taxpayers allege, inter alia, that an out-of-court statement and representation made by the Minister at the time of an audit in respect of the 1979 to 1982 taxation years led them into error as to the deductibility of the interest expenses, so that they took out further loans of the same nature during the subsequent taxation years; that their cases were treated differently from those of other shareholders involved in similar investments; and that the assessment is arbitrary in that the Minister did not follow his own policy which was known and in force during the period in question. The plaintiffs do not limit their claim to the remedies specifically set out in section 177 of the Act, but further seek a declaratory judgment holding that the reassessments in question are void, on the ground that the Minister did not have the authority to make them, in view of the fact that they were arbitrary and discriminatory and that they were made contrary to the duty of the Minister to act fairly. It is these points in the statements of claim that are the subject of this motion to strike.

It is well known in motions to strike that the Court must take the allegations of fact set out in the pleading or pleadings in question as proven. Moreover, the applicant must establish that it is plain and obvious that the pleading in question does not disclose any reasonable cause of action (see Operation Dismantle Inc. v. The Queen, [1985] 1 S.C.R. 441, 18 D.L.R. (4th) 481).

In this case, it is not immediately plain and obvious that this is so, given that counsel had to argue the matter for an entire day. On the other hand, this is a complex case and, while I do not propose to take the time to reiterate all the arguments and all the case law argued during the hearing of this motion, an overview of the parties’ arguments will be useful.

The applicant asserts that in principle an interest expense is not deductible in computing a taxpayer's income if it was incurred in respect of a claim or a debt that is capital in nature. Since an interest expense is essentially capital in nature, deduction of such an expense is theoretically not allowed under paragraph 18(1 )(b) of the Act (see the reasons of Chief Justice Dickson in Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059, at page 45 (C.T.C. 124, D.T.C. 5064)). The statutory exception set out in subparagraph 20(1 )(c)(i), cited supra, provides that the money borrowed must be used for the purpose of earning income in order for the interest paid on it to be deductible. In the present case, the plaintiffs contend that they in fact borrowed for this purpose, and that is what the judge hearing the case on the merits will have to determine.

According to the applicant, in order to make this determination the Court will not have the power to go against the Act and vacate the reassessments for other reasons that are not provided in the Act, such as the reasons argued by the plaintiffs, with which this motion to strike is concerned. The applicant relies on the principle laid down by the Exchequer Court in M.N.R. v. Minden, [1962] C.T.C. 79, 62 D.T.C. 1044, at page 89 (D.T.C. 1050), which holds that in considering an appeal of an assessment the Court must examine the validity of the assessment and not the correctness of the reasons relied on by the Minister in making the assessment: an assessment may be valid even if the reasons relied on by the Minister are incorrect. This principle was reiterated in Riendeau v. M.N.R., [1991] 2 C.T.C. 64, 91 D.T.C. 5416, at page 65 (D.T.C. 5417), in which the Federal Court of Appeal noted that the Minister’s reasoning in making an assessment cannot affect a taxpayer's liability to pay the tax imposed by the Act itself.

The applicant asserts that neither the audit for the earlier taxation years, nor the Minister’s confirmation of the assessments made for those taxation years, nor the fact that the plaintiffs relied on that last point in continuing to incur interest expenses for 1981 to 1985 constitutes a reasonable cause of action. According to the applicant, these arguments are bad in law: under subsection 152(4) of the Act, the Minister has the statutory power to make a reassessment at any time within the limitations imposed by the Act (i.e., three or four years, depending on the years in issue), which establishes that he is not bound by the earlier assessments.

The applicant cites the decision in Russell v. M.N.R., [1977] C.T.C. 2473, 77 D.T.C. 334, at page 2479 (D.T.C. 338-39) (T.R.B.) (see also Neeb v. Canada, [1991] 1 C.T.C. 41, 90 D.T.C. 6666 (F.C.T.D.), at page 46 (D.T.C. 6669)), in which the Minister issued an assessment three times for the same taxation year. The taxpayer argued that he had been subject to unfair and inequitable treatment, but the Court dismissed this argument on the ground that the Minister could and had to correct incorrect assessments within the time allowed by the Act. Similarly, the courts have on several occasions affirmed the principle that the Minister is not bound by assessments issued for other years. [1]

With respect to the acts and representations of agents of the Minister alleged in the plaintiffs’ statements of claim, the applicant contends that these grounds of appeal cannot be raised if they are contrary to the application of the Act. She cites the decision in M.N.R. v. Inland Industries Ltée, [1974] S.C.R. 514, [1972] C.T.C. 27, 72 D.T.C. 6013, at page 523 (C.T.C. 31, D.T.C. 6017), in which Pigeon, J. held, with respect to the earlier approval of a pension plan by the Minister for registration purposes: ‘’. . .it seems clear to me that the Minister cannot be bound by an approval given when the conditions prescribed by the law were not met.” The applicant points out that citing principles of administrative law will not result in the Minister being bound by representations made by his agents, if the representations in question are inconsistent with the applicant Act: what counts is not the interpretation given by the Minister, but the application of the Act as it stands.

With respect to discrimination against the plaintiffs, the applicant alleges that even if the plaintiffs were treated differently from other investors in similar cases, that is not sufficient to vacate an assessment. According to the applicant, this principle derives from the decisions in Torland Investments Ltd. and Carter, supra. Moreover, in Hutterian Brethren Church of Wilson v. The Queen, [1979] C.T.C. 1, 79 D.T.C. 5052 (F.C.T.D.); aff'd [1980] C.T.C. 1, 79 D.T.C. 5474 (F.C.A.), the appellants argued that the manner in which the Minister treated other communities of the same church was more favourable than the manner in which he treated their community, and that the assessment he made in their regard was therefore invalid. The Federal Court dismissed the appeal on the ground that even if the arrangements with the other communities were illegal, that was not a ground to declare the Minister’s assessment of their community invalid.

The applicant refers to Hokhold v. Canada, [1993] 2 C.T.C. 99, 93 D.T.C. 5339, which applies, at page 106 (D.T.C. 5334), the comments of the Assistant Chief Justice of this Court under the Excise Tax Act, R.S.C 1985, c. E-15 in Ford Motors Co. of Canada v. M.N.R., Court File No. T-3700-82, May 8, 1991 (Jerome, A.C.J.) (unreported), to the field of tax law. In that case, it was held that the fact that the activities of other businesses of the same nature are similar to those of a plaintiff is of no relevance, because otherwise the result would be an administrative upheaval. The applicant asserts that the Act is identical for everyone, even if the administration cannot correct all incorrect returns (see Bergeron v. M.N.R., Court File No. 90-1118 (unreported), at page 5).

The applicant contends that certain allegations of fact in respect of the supposedly discriminatory treatment imposed on the plaintiffs may require such voluminous evidence that to introduce it might embarrass or delay the fair trial of the action, by prolonging it unreasonably by a parade of witnesses and investors. Moreover, the Canadian taxation system is based on the principle of selfassessment, that is, that it is up to each taxpayer to compute his or her own income tax (see Canada v. McKinlay Transport Ltd., [1990] 1 S.C.R. 627, [1990] 2 C.T.C. 103, 90 D.T.C. 6243, at page 648 (C.T.C. 113, D.T.C. 6250)). The Act does not provide that each taxpayer must submit all his or her documents to the Minister’s officials in order for them to determine his or her taxable income. The Minister relies on taxpayers, and occasional examination or a system of random audits may be the only methods of preserving the integrity of the self-assessment system.

With respect to the plaintiffs’ allegations concerning a policy within the Department of allowing an interest deduction even with respect to shares which do not produce dividends, the applicant asserts that the Minister is not bound by his own opinions or the policies of his Department when that opinion or those policies are contrary to the Act. She points out that in Stickel v. M.N.R., [1972] C.T.C. 210, 72 D.T.C. 6178 (F.C.T.D.), at pages 217-18 (D.T.C. 6184), this Court held that the fact that the Minister did not assess in accordance with his own representations, as published in an interpretation bulletin, cannot be set up against the Minister. Moreover, the Department's policies cannot constitute estoppel or a ground of nullity because they cannot go against the Act. According to the applicant, representations relating to the Minister's own legal opinion cannot be set up against the Minister as an argument in law for vacating an assessment (see No. 358 v. M.N.R. (1956), 16 Tax A.B.C. 14, 56 D.T.C. 466, at page 17 (D.T.C. 468)).

Finally, with respect to the jurisdiction of the Court over the remedies sought by the plaintiffs in this case, the applicant contends that the plaintiffs are not entitled to a declaratory judgment and that the Court cannot award any other remedy than those provided by the Act. The remedies provided in section 177 are as follows:

177. The Federal Court may dispose of an appeal, other than an appeal to which section 180 applies, by

(a) dismissing it; or

(b) allowing it and

(i) vacating the assessment,

(ii) varying the assessment,

(iii) restoring the assessment, or

(iv) referring the assessment back to the Minister for reconsideration and reassessment.

The applicant relies on the decision in Flemming Estate v. M.N.R., [1984] C.T.C. 352, 84 D.T.C. 6345 (F.C.A.), at pages 352-63 (D.T.C. 6346), concerning a taxpayer who challenged the validity of the Minister’s assessment by applying for certiorari under section 18 of the Federal Court Act, R.S.C. 1970, 2nd. Supp., c. 10. The trial judge found for the taxpayer. The Federal Court of Appeal reversed that decision on the ground that the only way for the taxpayer to challenge the Minister’s assessment was to proceed under the provisions of the Act. That Court reiterated the same principle in Optical Recording Laboratories Inc. v. Canada, [1990] 2 C.T.C. 524, 90 D.T.C. 6647, at pages 530-31 (D.T.C. 6652). Accordingly, the plaintiffs may make their challenge only by appealing under the Act and not by way of declaratory judgment.

Of course, the plaintiffs see the merits of their cause of action from a different perspective. First, they assert that the allegations of fact in their statements of claim, which are taken as true, disclose an at least arguable cause of action. In their view, they involve questions of evidence that the trial judge will have to weigh. The plaintiffs point out, with case law in support, [2] that if the Court is not persuaded that it is plain and obvious that the action is futile and has no chance of success, they must not be deprived of their right to be heard (Gund Inc. v. Ganz Bros. Toys Ltd. (1989), 23 C.P.R. (3d) 344, 23 C.I.P.R. 86, at page 346 (C.I.P.R. 88) (F.C.T.D.)). The Court must hesitate to strike the pleadings in question unless they are clearly immaterial or unimportant (see Rothschild v. Custodian of Enemy Property, [1945] Ex. C.R. 44, at pages 48-49), particularly when they appear, as in this case, to be closely related to the merits or the action (see Attorney General v. Rickards (1843), 6 Beav. 444, 49 E.R. 897, at pages 449-50 (E.R. 899-90) (Ch.)). Moreover, these pleadings are not subject to being struck in that they are not allegations of fact, but the legal arguments to be made in relation to the facts alleged (see U.S. Natural Resources Inc. v. Moore Dry Kin Co. of Canada, [1973] F.C. 225, 9 C.P.R. (2d) 11, at page 228 (C.P.R. 14) (F.C.A.)).

The plaintiffs contend that under the provisions of the Civil Code of Lower Canada and the principles of estoppel, it is at least arguable that the defendant is bound by the Minister's admission ("aveu") and by his representations of fact, on which they relied, to their prejudice. First, an admission ("aveu") is a judicial admission that cannot be retracted without leave of the Court (see Canderel Ltd. v. Canada, [1993] 2 C.T.C. 213, 93 D.T.C. 5357 (F.C.A.), Continental Bank Leasing Corp. v. Canada, [1993] 1 C.T.C. 2306, 93 D.T.C. 298 (T.C.C.)). Second, the Minister's representations meet the essential elements of estoppel, [3] which applies to the Crown: [4] the Minister is foreclosed from alleging as a fact that the interest expenses in question were not incurred for the purpose of earning income.

The plaintiffs assert that the courts have frequently had recourse to the interpretation of administrative policies in their own determinations of federal taxation provisions (see Vaillancourt v. The Queen, [1991] 2 C.T.C. 42, 91 D.T.C. 5352, at page 48 (D.T.C. 5356-57) (F.C.A.)), and that the validity of this approach has been confirmed by the Supreme Court of Canada. [5] It follows that it is at least arguable that the Minister’s policies are an important tool for the judicial interpretation of the effect of paragraph 20(1 )(c).

The plaintiffs also advance arguments based on fairness. In their view, it is at least arguable that in administering the Act, the Minister is bound to act fairly. In light of his own policy, the Minister breached his duty to the plaintiffs when he disallowed, retroactively and without prior notice, deduction of their interest expenses. In fact, the courts have ruled against the retroactive application of changes in administrative policies, including tax policies. [6] It follows that it is at least arguable that the Minister could not simply ignore or reverse, retroactively, his own policies in respect of the application of paragraph 20(1 )(c) of the Act.

In reply to the argument that considerations of fairness do not permit a court not to apply the Act as it stands, the plaintiffs contend that this question is far from settled: [7] the law of fairness, like other areas of the law, is in a state of change, and the liability of the Crown for the consequences of errors attributable to its own representations is in the process of being expanded (see, for example, Guérin v. The Queen, [1984] 2 S.C.R. 335, 13 D.L.R. (4th) 321, at page 389 (D.L.R. 344)). Moreover, because of its inherent complexity, more flexible application of the doctrine of fairness is required in the tax law context.

The plaintiffs dispute the applicant's argument that the Court has no power to enforce the Minister's policies in an appeal under the Act. In view of the selective application of these current policies, this amounts, in their opinion, to giving the Minister complete freedom to target taxpayers as he sees fit by means of assessments that are contrary to his own policies. The plaintiffs contend that it is at least arguable that the Court is not without any power in such circumstances.

In the plaintiffs’ view, it was essentially contrary to fairness to make the reassessments in question. According to them, the Minister had expressly stated that the taxpayers would not be subject to reassessments in the taxation years following a satisfactory audit. They refer to paragraph 3(c) of Information Circular 75-7R3, which provides:

3. All pertinent aspects are studied to determine whether a return is to be reassessed within the four-year limit. The Department will normally

(c) not reassess where the understatement of tax in the return for the year should have been apparent to the Department, considering the degree of examination and audit that the return received

With respect to their allegations of discriminatory treatment, the plaintiffs assert that it is at least arguable that the Minister ought not to have applied the Act arbitrarily or on the basis of irrelevant considerations. [8] Thus he could not target the plaintiffs in a discriminatory manner and disallow the deduction of interest expenses, when other taxpayers who had purchased similar shares could deduct those expenses, regardless of whether income was produced.

Finally, the plaintiffs emphasize that their appeal does not raise any question of jurisdiction. First, there is no doubt that the Court has jurisdiction over admissions ("aveu"), estoppel and statutory interpretation. Moreover, in the absence of statutory procedures that are specific to the arguments raised by the plaintiffs, this Court is the only forum with jurisdiction to dispose of the appeal under sections 175 and 177.

They further assert that the arguments that the Court may consider in an appeal under the Act are not limited to the quantum of tax, but include any matter relating to the validity of the impugned assessment. [9] The Court's duty to consider the remedies in this case is particularly apparent in that there is no right without an appropriate remedy. The plaintiffs point out that the courts have generally rebuffed attempts to reject the statutory procedures available, [10] including in tax cases. [11] According to the plaintiffs, it must be concluded that the statutory appeal provided by the Act is the only procedure for challenging an assessment, and that in such an appeal the taxpayer may raise any argument that is relevant to the validity of the assessment.

In the alternative, the plaintiffs contend that even if the Court has no jurisdiction under section 177 of the Act to consider the arguments they have raised, it nonetheless has jurisdiction to do so under the supervisory powers conferred by the Federal Court Act.

In my view, the plaintiffs’ arguments cannot be accepted. Although their counsel's arguments are imaginative and attractive, nonetheless, as noted earlier, the case law has clearly established that the Minister is not bound by his earlier assessments, or by his earlier policies, or by his representations or the representations of his agents, or by the treatment he gives or has given to other taxpayers. The Minister’s duty is to apply the Act as it stands. The Act authorizes the Minister to amend his assessments and requires that he make assessments in accordance with the provisions of the Act. Moreover, in an appeal from an assessment the Court is limited to the remedies provided by the Act and cannot give a declaratory judgment.

Accordingly, the motion is allowed and the impugned paragraphs are struck from the plaintiffs’ statements of claim, with costs.

Motion allowed.