Income Tax Disputes Involving Loss Years: Pitfalls, Foibles, and Possible Reforms

Abstract

Tax disputes involving losses can be challenging to resolve owing to two longstanding principles, commonly known as "the nil assessment rule" and "the New St James principle." The nil assessment rule bars taxpayers from objecting to assessments that result in no tax being payable--including both loss years and profitable years where income is completely offset by carryovers. The New St James principle provides, essentially, that loss years or years with no tax payable never become statute-barred. Because the nil assessment rule and the New St James principle can prevent the resolution of disputes over tax loss balances in a timely manner, Parliament amended the Income Tax Act in 1977 so as to allow, in certain situations, for the issuance by the minister of national revenue of a notice of determination of losses (NODL) for a given taxation year. Once issued, a NODL can be objected to or appealed in basically the same manner as an assessment and, subject to any objection or appeal, becomes binding upon the minister and the taxpayer. However, the existence of a parallel but distinct system for resolving loss disputes leaves gaps that result in a range of procedural traps for taxpayers. Taxpayers caught in these traps can potentially end up losing their rights to object to or appeal disputed income adjustments, reviving statute-barred issues, or being required to pay arrears interest on extinguished tax debts. This article explores some of these traps, showing how they arise and what a taxpayer might do to avoid being caught by them. It also discusses whether the time has come to reform the nil assessment rule and/or the New St James principle so as to allow disputes involving losses to be resolved more readily by the Tax Court of Canada, and proposes several possible reforms.