The Federal Court of Appeal Sends Another Decision Back to the Tax Court of Canada in Heron Bay v. The Queen (2010)

In recent weeks, the Federal Court of Appeal has sent two cases back to the Tax Court of Canada for rehearing. In GlaxoSmithKline Inc. v. The Queen, 2010 FCA 201 (discussed here), the Court of Appeal found that Rip C.J. erred by misunderstanding the application s. 69(2) of the Federal Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (“ITA”).

In this latest case, Heron Bay Investments Ltd. v. Her Majesty the Queen, 2010 FCA 203, the Federal Court of Appeal (reasons for judgment by Sharlow J.A.) ruled that the actions of Hogan J. in Heron Bay Investments Ltd. v. The Queen, 2009 TCC 337 gave rise to a reasonable apprehension of bias and breached “the rules of procedural fairness.” The case was sent back to the Tax Court for retrial by another judge.

Background and Facts

The Heron Bay Corporation is a member of the Conservancy Group of corporations, which includes Rosehue Downs Developments Inc., Burlmarie Developments Inc., Shellfran Investments Ltd., Marlo Developments Inc., and Viewmark Homes Ltd. The Rosehue and Burlmarie corporations entered into an agreement to purchase property from Runnymede Development Corporation Ltd., an arm’s length corporation. Marlo, along with Shelfran and Viewmark, entered into an agreement to purchase the property from Rosehue and Burlmarie. Viewmark borrowed from Heron Bay for the purchase.

For the 1995 tax year, Heron Bay deducted the amount of the loan to Viewmark. According to Heron Bay, the loan was doubtful because the value of the property interest bought by Viewmark was less than the purchase price, thus there was a reasonable doubt that it would be repaid.

For tax purposes, a doubtful loan is one that stands the chance of not being reimbursed in full. The deducted amount must be included as income in the following year. But, if  the loan is still doubtful at the end of the year a new deduction is allowed. This can be repeated until the debt is recovered or is no longer doubtful. At that point the deduction is included as income. (If the loan becomes bad or uncollectible it can be deducted per s. 20(1)(p)(ii) of the ITA).

Pursuant to s. 20(1)(l)(ii) of the ITA, the amount of a doubtful loan can only be deducted from income if certain conditions are realized. The criteria in the present case were as follows:

(1) in the year in which the deduction is claimed, the taxpayer’s ordinary business must include the lending of money;

(2) the loan in respect of which the deduction is claimed must be made in the ordinary course of the taxpayer’s money lending business; and

(3) the loan must be doubtful at the end of the year in which the deduction is claimed, meaning that there must be a reasonable doubt that it would be collected.

The Tax Court of Canada ruled that the first criterion under s. 20(1)(l)(ii) was met; the year in which the deduction was claimed the taxpayer’s ordinary course of business included the lending of money. However, criterion two and three were not fulfilled—the loan was not “made in the ordinary course of the taxpayer’s money lending business” and there was not a reasonable doubt that at the end of the relevant taxation year the loan would be repaid. Hence, the deduction was disallowed.

The Federal Court of Appeal

Before the Federal Court of Appeal, Heron Bay argued that Hogan J. of the Tax Court was “wrong in law” by finding that criterion 2 and 3 were not met. Also, Heron Bay maintained:

the judge deprived Heron Bay of procedural fairness by considering authorities not cited by either party without giving the parties an opportunity to make submissions on those authorities, considering issues not pleaded by either party without giving the parties an opportunity to make submissions on those issues, and intervening excessively in the examination of witnesses, giving rise to a reasonable apprehension of bias.

At trial, Hogan J. referenced authorities not referred to by Heron Bay or the Minister. For example, Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601 was not cited in the reasons of Hogan J., but referred to in his deliberations. As well, Hogan J. considered journal articles and additional secondary sources not cited or referred to by Heron Bay or the Minister. Nevertheless, according to the Court of Appeal, this alone did not indicate a breach of procedural fairness:

The judge cannot be precluded from referring in his deliberations to cases that are not cited by a party and are not referred to in his reasons…Nor can the judge, when addressing a legal issue raised by a party, be precluded from referring to a case he considers relevant to that issue merely because the case was not cited by a party… As to the judge’s reliance on articles by learned authors, it seems to me that he has simply adopted from those articles excerpts (including case references) stating principles that the authors have derived from jurisprudence relevant to the issues raised in the appeal…

According to the Court of Appeal, a “breach of procedural fairness” might have occurred if Hogan. J had relied on the impugned authorities to introduce “a principle of law that was not raised by either party expressly or by necessary implication, or had taken the case on a substantially new and different analytical path.”

It was Hogan J.’s application of s. 69 of the ITA, without allowing Heron Bay to make relevant submissions, that the Court of Appeal ruled a breach of procedural fairness. Section 69(1)(a) states that the acquisition of anything from someone at non-arm’s length, at greater than the fair market value, is deemed for tax purposes to have been acquired at fair market value. The Federal Court of Appeal ruled that even though this reference to s. 69 was a breach of procedural fairness, it was obiter and did “not justify a retrial.”

In the end, a retrial was ordered due to concerns regarding the Tax Court judge’s excessive intervention in examinations and cross-examinations. Excessive intervention by a judge can warrant a new trial (see James v. Canada (2000), [2001] 1 C.T.C. 227 (F.C.A.); R. v. Brouillard, [1985] 1 S.C.R. 39).

According to the Court of Appeal, the Tax Court judge “seemed to fall into the habit of taking over the questioning.” Moreover, Hogan J., during the examination of one witness, “adopted a position in opposition to Heron Bay on a critical issue in the case, giving rise to a reasonable apprehension that the judge was not a fair and impartial arbiter.”