Canada v. Merchant Law Group: FCA Recommends Written Agreement Establishing Client’s Consent to Disbursements

You may have heard of the Merchant Law Group Inc., a full-service firm centered in Saskatchewan. It has been involved in numerous class actions, its most famous involving a claim against the government for the residential school abuses suffered by Canada’s First Nations communities. That action was marred by significant controversy surrounding the way in which the firm solicited its First Nations clients and the amount of the financial settlement that went to the Merchant Group. According to some reports, the firm collected $25 million in legal fees from the government.

The Federal Court of Appeal decision in Canada v. Merchant Law Group, 2010 FCA 206, is a more recent, albeit less controversial case involving the Merchant Law Group and the subject of legal fees. The appeal court ruled that the firm failed to meet the requisite onus to establish that it was acting as an agent for the client when certain disbursements were incurred. As a result, the firm was found responsible for collecting and remitting the requisite GST.

This case is notable for providing guidance on the level of evidence required to prove the existence of an agency relationship when a claim is made that certain disbursements were incurred during the provision of legal services.

Background and Law

The Merchant Group was reassessed by the Minister of Finance (“Minister”) over the possible inappropriate tax treatment of disbursements incurred during the provision of legal services. This included payments for items such as courier fees, travel expenses, expert reports and testimonies, etc. According to the Minister’s reassessment, the firm failed to collect and remit the applicable Goods and Services Tax (“GST”) pursuant to the relevant provisions of the Excise Tax Act, R.S.C. 1985, c. E-15 (“ETA”). The Tax Court of Canada disagreed with that assessment in Merchant Law Group v. The Queen, 2008 TCC 337.

Pursuant to s. 165(1) of the ETA, GST in the amount of 5% has to be remitted to the government by “every recipient of a taxable supply…on the value of the consideration of the supply…” A “supply” is defined as “the provision of property or a service in any manner, including sale, transfer, barter, exchange, licence, rental, lease, gift or disposition…” A “taxable supply” is defined under s. 123(1) of the ETA as a “supply that is made in the course of a commercial activity…” Finally, the ““recipient”” of a supply of property or a service means…where consideration for the supply is payable under an agreement for the supply, the person who is liable under the agreement to pay that consideration…”

The Presumption of an Agency Relationship between the Lawyer and Client Will Not Do

The issue in the present case was whether or not the evidence presented by the Merchant Group was sufficient to establish the existence of an agency relationship. When incurring disbursements in the course of providing legal services, a lawyer who can sufficiently prove that she acted as the agent for the client is not, as mandated by the ETA, the “recipient of that taxable supply” because “the person who is liable under the agreement to pay…consideration” is the client. Therefore, the lawyer is not responsible to charge and remit the GST.

In contrast, the evidence may suggest that the lawyer herself incurred the disbursement during the provision of legal services. In this case, under the law the recipient of the supply is the lawyer and she is responsible for the GST because it was her, and not the client, who was obligated under an agreement to reimburse the third-party. (Note, in such an instance the GST can be claimed under a tax credit and the client is charged the amount minus the GST.)

In making its case, the Minister relied on GST/HST Policy Statement P-209R entitled “Lawyers and Disbursements” (“Policy”), which lists certain expenditures that are eligible to be considered as incurred within an agency relationship. This includes, for example, fees to commence a legal proceeding, filing fees (e.g. notice of intent to defend), or subpoena fees.

The impugned disbursements in the present case (including courier costs, transcript production, and travel expenses) did not fall within the range of those acceptable under the aforementioned Policy. Nevertheless, the Tax Court ruled in favour of the Merchant Group by relying primarily on the general nature of the solicitor-client relationship, in addition to the guidance set by GST/HST Policy Statement P-182R Agency.

According to Justice E. P. Rossiter of the Tax Court, “[i]t is trite to say that the relationship that exists between a solicitor and his client is one of principal and agent.” Furthermore, the key factors establishing an agency relationship set out in the P-182R were met. Nonetheless, the Federal Court of Appeal ruled that the lack of a written agreement was determinative.

A  Written Agreement Establishing the Client’s Consent to Disbursements Incurred on her Behalf is Recommended

Unfortunately for the Merchant Group, a presumption that an agency relationship existed between the client and the lawyer was not sufficient for the Federal Court of Appeal. In his written reasons for judgment Chief Justice Blais stated:

The [Tax Court] Judge erred in law by relying upon the general nature of the solicitor-client relationship. As a matter of law it does not follow that, because the solicitor-client relationship is generally one of agency, all financial obligations incurred by a lawyer while providing legal services are incurred as agent of its clients…

According to the appeal court, to “establish the lawyer was not the recipient of a taxable supply at least some evidence must be led with respect to the particular transaction and the extent of the lawyer’s ability to bind his or her client to the transaction…” Most importantly, a written agreement demonstrating that the client consented to the lawyer making certain disbursements on her behalf is recommended. Furthermore, Chief Justice Blaise suggested that a written agreement may even “constitute sufficient evidence” to have disbursements not within the range of those allowed by the Policy treated in the desired way.

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