Case comment on Lehigh Hanson Materials Limited v. His Majesty the King

In Lehigh Hanson Materials Limited v. His Majesty the King,¹ the Tax Court of Canada (“Court”) permitted the Crown to amend the Reply in a transfer pricing appeal after both the normal reassessment period in the Income Tax Act² and the period for obtaining relief from international double taxation under the Canada-U.K. Tax Convention had passed.³ The amendments were to adjust the transfer price of an entirely different item than was originally the case. Surprisingly, in the circumstances, the Court determined that the Crown’s proposed amendments to the Reply would not result in an injustice to the taxpayer that was not compensable by an award of costs. Late amendments to pleadings in a tax appeal are normally permitted, but only if the other party does not suffer an injustice that is not compensable by a costs award and the amendment serves the interests of justice.

The facts can be summarized (and simplified) as follows:

1. The taxpayer is a member of a multinational corporate group.  In 2009, the group implemented a corporate reorganization.
2. As part of the corporate reorganization, the taxpayer purchased an interest in a related co-operative entity resident in The Netherlands (the “Co-op Interest”) from the taxpayer’s UK-resident parent company.  The taxpayer paid $1.75 billion to the UK-resident parent company for the Co-op Interest.  The $1.75 billion consideration consisted of:  (i) a share of the taxpayer (the share had nominal value); (ii) a cash payment of $229,627,248; and (iii) an unsecured, interest-bearing promissory note (the “Promissory Note”) for $1.521 billion.
3. The Promissory Note had an interest rate of 8.1% and a term of 20 years.  The taxpayer deducted the interest paid on the Promissory Note.
4. The Canada Revenue Agency (“CRA”) reassessed the taxpayer under the transfer pricing rules in paragraphs 247(2)(a) and (c)⁴ for the taxpayer’s 2009 to 2015 taxation years, on the basis that the value of the Co-op Interest was approximately $411 million less than $1.75 billion purchase price (the “Valuation Issue”). CRA implemented this transfer pricing adjustment by reducing the principal amount of the Promissory Note by $411 million (the “Excess”) and then denying the interest deduction attributable to the Excess.
5.  The taxpayer applied to the Competent Authorities of the U.K. and Canada under the Treaty⁵ for relief on the basis of the transfer pricing adjustment regarding the value of the Promissory Note. 
6. In 2021, the taxpayer rejected the settlement proposal of the Competent Authorities, and in July 2022 the taxpayer commenced its appeal. The Crown’s Reply was filed in November 2022.
7. In January 2024, after the expiration of the normal reassessment period for the taxation years in issue and both the 3-year deadline to apply for competent authority relief and the 6- or 8-year deadline for adjusting income under the Treaty to relieve against international double taxation, the Crown notified the taxpayer that the Crown would amend the Reply to add an additional argument to support the amount reassessed. 
8. The additional argument was that the 8.1% interest rate and 20-year term of the Promissory Note did not reflect arm’s length terms (the “Interest Rate Issue”).  The Crown confirmed that it was not seeking additional tax by way of the new argument, but only supporting the existing reassessment amount on additional grounds.  The interest deducted on any amount in excess of an arm’s-length rate would be denied. The Crown did not advance what an arm’s length interest rate would be.
9. The Crown brought a motion for leave to file an amended Reply to include the Interest Rate Issue which the taxpayer opposed on several bases.  The Tax Court granted the Crown’s motion.

The Court discussed three sets of criteria that are relevant for determining whether the Crown should be permitted to amend the Reply to include the Interest Rate Issue.  First, section 54 of the Tax Court of Canada Rules (General Procedure) allows for a pleading to be amended after the close of pleadings with the consent of all the parties or “with leave of the Court, and the Court in granting leave may impose such terms as are just.”

Second, subsection 152(9) permits the Minister to advance an “alternative basis or argument” in support of an assessment, after the normal reassessment period. The Minister will not be permitted to do so where there is relevant evidence that the taxpayer is no longer able to adduce without leave of the court and it is not appropriate in the circumstances for the court to order that the evidence be adduced.

Both of these provisions provide the Court with discretion to examine the circumstances that led to the proposed additional arguments and corresponding amendments to a Reply to determine the extent of prejudice that a taxpayer would suffer, if the additional arguments and amended pleadings are permitted.

Third, case law sets out the principles that govern whether new arguments should be permitted and, correspondingly, the amended pleading allowed.  The Court noted the so-called “general rule” for permitting amendments to pleadings set out in cases such as Canderel v. R.:⁶

…the general rule is that an amendment should be allowed at any stage of an action for the purpose of determining the real questions in controversy between the parties. Provided, notably, that the allowance would not result in an injustice to the other party not capable of being compensated by an award of costs and that it would serve the interests of justice.

 Courts have proven amenable to permitting amendments to a Crown’s Reply and the introduction of new arguments.⁷  However, a Court will normally not permit an amendment to a Reply or a new argument to be introduced, if the amendment or argument introduces a new transaction rather than an alternative basis or argument in relation to the transactions actually assessed.  This principle is reflected in cases such as Walsh v. The Queen,⁸ which lays out the important restrictions for permitting new arguments under subsection 152(9):

[18] The following conditions apply when the Minister seeks to rely on subsection 152(9) of the Act:

1. the Minister cannot include transactions which did not form the basis of the taxpayer’s reassessment;
2. the right of the Minister to present an alternative argument in support of an assessment is subject to paragraphs 152(9)(a) and (b), which speak to the prejudice to the taxpayer; and
3. the Minister cannot use subsection 152(9) to reassess outside the time limitations in subsection 152(4) of the Act, or to collect tax exceeding the amount in the assessment under

The Court granted the Crown’s motion to amend the Reply, adding the Interest Rate Issue in addition to the existing Valuation Issue finding that there was no prejudice to the taxpayer. 

The key argument raised by the taxpayer was that the taxpayer would suffer non-compensable prejudice because the Interest Rate Issue was being introduced after the 6- or 8-year deadline for obtaining relief from international double taxation under the Treaty, and therefore the taxpayer was deprived of the ability to seek the assistance of the Competent Authorities in relation to the Interest Rate Issue. 

The Court rejected this argument on the basis that the Crown’s new argument did not introduce any new double taxation:

[38] In conclusion, on this point I do not accept that “injustice” would result from allowing the filing of the Amended Reply, stemming from inability of the Appellant to now apply for Competent Authorities relief from double taxation. The proposed Amended Reply does not itself introduce any new double taxation. And as stated the Appellant had previously had the Competent Authorities address the same double taxation, in the context of the Co-op Interest Value issue, with the Appellant ultimately refusing the compromise solution offered by the Canadian Competent Page: 9 Authority, thus maintaining the double taxation scenario prior to instituting this appeal.

This conclusion is surprising. The taxpayer’s previous dealings with the Competent Authorities were premised on CRA’s sole original basis of reassessment – the Valuation Issue - that the value of the Co-op Interest should have been $411 million less than what the taxpayer and its UK-resident parent company agreed to. It is entirely possible that the dealings and outcome with the Competent Authorities would have been different if discussions involved both issues – the Valuation Issue and the Interest Rate Issue. Because the Crown introduced the Interest Rate Issue after the period for obtaining relief from the Competent Authorities, the taxpayer was irreparably deprived of the opportunity to resolve the Interest Rate Issue through the Competent Authorities process.  It is difficult to see how a costs award can compensate for this deprivation.

The Court found that the relevant transaction is the same for both arguments (the Valuation Issue and the Interest Rate Issue),⁹, but another view is possible.  For the originally reassessed Valuation Issue, the relevant transaction was the taxpayer’s purchase of the Co-op Interest from its related UK-resident parent company.  For the new argument, the Interest Rate Issue-, the relevant transaction is the Promissory Note arrangement itself.  Although it is true that the Promissory Note arrangement is common to both issues, this is not the same as saying that the relevant transaction was the same for both issues. Different evidence would be adduced in respect of the Interest Rate Issue. As noted above, Walsh instructs that introducing a new argument under subsection 152(9) should not involve the introduction of a new transaction.

Indeed, one of the other arguments the taxpayer raised in opposition to the Crown’s motion to amend the Reply was that the proposed amendments would not assist the Court in determining the real issue in controversy, which the taxpayer contended was the fair market value of the Co-op Interest and not the interest rate or term of the Promissory Note. This is a strong argument. The adjustment reflected in the original pleadings was to deny the deduction of interest on the portion of the Promissory Note that exceeded the adjusted fair market value of the Co-op Interest.  No other adjustment was made. Accordingly, the interest rate and term of the Promissory Note were not in controversy before the Crown’s request to amend the Reply.

The Court disagreed with the taxpayer, saying that the underlying question is whether the ‘excess’ interest (attributable to the reduction in the value of the Promissory Note) was deductible.  In other words, according to the Court, this is a transfer pricing case involving the deductibility of interest, so it does not matter, for purposes of determining whether the Crown could amend the Reply, whether the basis for denying the interest deductions is the fair market value of the Co-op Interest or the interest rate or period of the Promissory Note.  Yet, as noted above, one could easily imagine that the evidence necessary to support the arm’s length price for the Valuation Issue could be quite different from the evidence necessary to support the arm’s length terms for the Interest Rate Issue.

The taxpayer has appealed the Court’s order allowing the Reply to be amended to the Federal Court of Appeal.¹⁰  In its notice of appeal, the taxpayer has alleged that the Court misapplied subsection 152(9) and the Treaty; and that the Court erred in determining that there would be no prejudice not capable of being compensated by an award of costs.

It will be interesting to see if the Federal Court of Appeal agrees with the Court’s analysis of whether permitting the Crown’s new argument and amended Reply gives rise to injustice for the taxpayer that is not compensable in costs, and what comments, if any, the Federal Court of Appeal will make as to whether, by seeking the amendments to the Reply, the Crown was attempting to introduce a new transaction.