Here is a pattern that surprises many taxpayers: a great many cases that are eventually won in the Tax Court of Canada — at trial or by settlement — were first lost at the CRA objection stage. In many of those files, the taxpayer had also failed to convince the auditor. In other words, two different CRA departments concluded the taxpayer was wrong before a judge concluded otherwise. Before a win or settlement in tax court, the taxpayer often has to lose twice.
After a notice of objection fails, people ask whether it is worth fighting on in tax court. Many simply roll over and accept that the CRA must have been right. But the agency is often wrong — and understanding why explains when it is worth continuing.
Inside the four walls of the CRA
Within the CRA, the agency wields enormous discretion and there is little compelling it to apply tax law strictly. Consider a taxpayer who keeps every receipt for vehicle expenses but no mileage log. An auditor can — and often does — deny all the vehicle expenses, even though neither the Income Tax Act nor the Excise Tax Act requires a taxpayer to keep an automobile log, and even though the expenses were entirely legitimate. The mileage-log requirement is an invention of the audit department, not a condition of the law. A travel log is good evidence of how a vehicle is split between business and personal use, but it is not the only way to prove the point.
CRA auditors frequently rely on arbitrary reasons to deny expenses or to treat amounts as undeclared income. Perhaps they err on the side of caution to protect the agency; perhaps they have an interest in making assessments as high as possible. Either way, many auditors take a very conservative approach to allowing expenses. If the documentation is not perfect, an auditor can disregard what was provided, leaving the taxpayer with little recourse but to object and, eventually, appeal.
The decisive difference: the rules of evidence
The reason cases turn around in court is that the CRA does not have to apply the rules of evidence — and the court does. The agency's assessments are deemed correct by law until the taxpayer successfully challenges them, no matter how wrong they may actually be. So whatever errors the auditor or appeals officer makes, the agency is treated as right. And auditors and appeals officers often disregard, misunderstand, or decline to apply the rules of evidence, giving more weight to their own theories and suspicions than to the evidence the taxpayer provides.
The law of evidence determines what a judge must and must not consider, and it assigns relative weight: direct evidence outweighs circumstantial evidence, which outweighs a mere suspicion. Judges know this. Department of Justice counsel know this. To the CRA at the audit and objection stages, it simply does not matter.
The practical consequence is striking. A taxpayer with no receipts for the construction of a house, whose building expenses were all denied, can go before a judge and give oral testimony about those expenses. They can offer before-and-after photographs, bring witnesses, and swear under oath that the costs were paid — and win, without producing a single receipt. The same taxpayer's audit would have gone nowhere without receipts, no matter how many people offered evidence to the auditor. A witness who testifies in criminal court does not need a video to establish that a crime occurred; their eyewitness account is direct evidence and, absent conflicting evidence, is generally accepted. Tax court is no different.
The same principle rescues taxpayers whose records are imperfect rather than absent. Where only secondary proof of an expense exists — a credit-card statement, a bank record, a sworn affidavit — an auditor will typically take the most cautious position and deny the expense, forcing the taxpayer to object. A judge, by contrast, will weigh that secondary evidence and the taxpayer's testimony against the CRA's theories and assumptions, and will generally give the evidence the greater weight. That difference in how the two forums treat imperfect proof is precisely why a file that looks hopeless inside the agency can succeed once it leaves the four walls of the CRA.
Why the Department of Justice settles
If the CRA has no real evidence to undermine the taxpayer's credibility or their testimony at trial, its case is weak. An assumption built on circumstantial evidence — a Mercedes in the driveway against $20,000 of declared income, for instance — will not overcome actual evidence. Going to trial with a weak case risks losing and being ordered to pay costs to the taxpayer.
Department of Justice counsel are busy, well educated, and reasonable, and they understand the law of evidence. They are too occupied to try cases built entirely on a theory with no supporting evidence, and their knowledge lets them predict how a court would rule. Where the CRA might ignore imperfect evidence and decide against the taxpayer, counsel who believe a judge would find for the taxpayer are typically willing to reach a reasonable pre-trial settlement. That analysis is performed at the Department of Justice level but not at the CRA level — which is one reason a correct outcome is far more likely once the file reaches DOJ counsel than while it sits with the agency.
The mechanics of a Tax Court appeal
An appeal to the Tax Court of Canada begins with a notice of appeal, in which the taxpayer sets out the case. This stage matters: what is not raised in the notice of appeal may not be admissible later, so it pays to be thorough. The Department of Justice then assigns counsel to represent the CRA (the Respondent), who replies to the notice of appeal, setting out the facts admitted and denied, the Minister's assumptions of fact, the issues, the statutory provisions relied on, and the relief sought.
In the general procedure, the parties exchange books of documents and then conduct examinations for discovery — sitting down in a court reporter's office, where each side questions one witness to learn the other's position and evidence. After discovery, both sides have a clear view of the case, which is the prime moment to settle. A settlement is not a haggle, like negotiating for a used car; it has to be a "principled settlement" grounded in the merits. If the taxpayer has strong evidence on three of four issues and a weak position on the fourth, a principled settlement may have the CRA concede the three and hold the fourth. In practice, the large majority of these cases settle in the taxpayer's favour before trial — usually not because of how a section of the Act should be read, but because of a bad audit that convincing evidence simply exposes.
What the Tax Court can and cannot do
One important limit: the Tax Court of Canada is not a court of equity. Unlike a provincial superior court judge, a Tax Court judge cannot decide a case on what would be fair under the circumstances — the decision must follow the law. So a judge cannot, for example, reduce a gross negligence penalty from 50% to 10% simply because the full penalty seems harsh; the penalty either meets the legal standard or it does not. The court is also strict about timing. Where the objection stage allows a late extension of up to a year, the Tax Court often requires a taxpayer to appear and justify any extension request, so it is best to be on time. A separate forum, the Federal Court, handles a different kind of grievance: challenges to how the CRA exercised its discretion — for instance, an arbitrary denial of taxpayer relief or a rejected payment plan — through judicial review, which must be commenced within 30 days of the decision.
How the objection and appeal fit together
A notice of objection must be filed within 90 days of the assessment or reassessment, and a late objection can be extended by up to a year. There is a useful tactical wrinkle here: because an appeals officer may not be assigned for the better part of a year, an objection can be filed initially with a short statement that the assessed amount is incorrect, reserving the detailed case for later. That avoids rushing a sloppy submission inside 90 days and buys time to assemble a comprehensive, well-organized package by the time the appeals officer is assigned — making it easy for the officer to decide in the taxpayer's favour.
For income tax matters, a taxpayer can skip the appeals officer and go straight to the Tax Court of Canada once 90 days have passed since the objection was filed; for GST/HST, the wait is 180 days. The Tax Court has two streams — the informal procedure (a limit of $25,000 per year, no filing fee, no lawyer required, and a corporation may represent itself) and the general procedure (specific timed steps, filing fees, and, for corporations, a lawyer in almost all cases). In all matters other than gross negligence penalties, the onus is on the taxpayer to prove the case; on the penalties, the CRA bears the burden.
The bottom line: even if you lose, and lose again, you may win in tax court — because where tax is concerned, three times can be the charm. For the underlying service pages, see tax disputes and objections and the Tax Court of Canada, and our companion guide on the gross negligence penalty.
This chapter grew out of an article first published in The Lawyer's Daily. This guide draws on Dale Barrett's book "Victory Over the CRA", written for accountants who represent their clients in disputes with the Canada Revenue Agency.