by Teresa Farnsworth June 17, 2022

Written By Guest Blogger S.M. Oliva 

Canadian Court Refuses to Compensate U.S. Firm for $1.4 Million in Interest Incurred During Successful Sales Tax Challenge

Contesting a sales tax audit is often a long and expensive process. Even if the business contesting the audit prevails, it may still be on the hook for thousands of dollars in costs and legal fees. And there is no guarantee that any of those losses will be recoverable. 

A recent court decision from the Ontario Court of Appeal, Jayco Inc. v. Canada (Revenue Agency) provides a cautionary tale in this regard. This case involved a United States-based business that contested a Canadian sales tax audit. While the business won that case, it then mounted an unsuccessful effort to recover nearly $1.5 million in costs associated with the earlier litigation.

jayco logoIndiana-based Company Argued It Did Not Have to Collect Sales Tax on U.S. Sales to Canadian Dealers

The business in this case, Jayco, Inc., is based in Indiana. Jayco manufactures recreational vehicles, as well as individual parts in such vehicles. Jayco sold a number of RVs and parts to dealers based in Canada. Some of the parts sales occurred in Canada, which meant Jayco had to collect and remit Canada’s harmonized sales tax (HST) on such purchases. This much was not disputed by Jayco. Where a disagreement did arise was over RV and parts sales that Jayco claimed occurred at its factory in the United States. The Canada Revenue Agency (CRA) conducted an audit and determined that since these sales were “delivered” in Canada, they were also subject to the HST.

In March 2012, the CRA assessed $14 million in uncollected sales tax against Jayco. Six years of administrative appeals and litigation followed. In February 2018, the Tax Court of Canada determined that Jayco was correct with respect to the sale of its RVs. The delivery of those sales took place at Jayco’s “place of business” in the United States. So Jayco was not required to collect any Canadian sales tax owed on those specific purchases. Ontario Court of Appeal Finds No “Duty to Indemnify” Successful Sales Tax Challengers Jayco’s victory did end the litigation.

When Jayco initially appealed the CRA’s assessment to the Tax Court, Canadian law required the company to “pay or secure the amount of the assessment pending the appeal.” This meant Jayco had to take out a line of credit to cover the full $14 million sales tax assessment. As the original litigation dragged on, Jayco then had to increase the amount its letter of credit by an additional $5 million to account for accrued interest. After Jayco prevailed in the Tax Court, it terminated the letter of credit. But it still had to pay $1,231,984.52 in interest. The company was also liable for $242,000 in consulting fees associated with its appeal. Jayco therefore filed a second lawsuit against the Canadian government, seeking “indemnity” for these expenses.

Essentially, Jayco argued that since it was considered an “agent” of the Canadian government for the purpose of collecting and remitting sales tax, the government–as the “principal”–was required to indemnify the company against the costs of defending against the CRA’s audit.

But in March 2021, Justice Jennifer L. Myers of the Ontario Court of Justice rejected that argument and dismissed Jayco’s lawsuit. She held “[t]here was no right to indemnity” based on binding precedent from the Supreme Court of Canada.

Specifically, nothing in Canada’s sales tax statutes provide for a right to recover costs incurred by private businesses “in carrying out their duties” to collect sales tax.

Jayco appealed, but the Ontario Court of Appeal agreed with Justice Myers and again dismissed the case. Writing for a three-judge panel, Justice Gladys I. Pardu reiterated there was no “private law duty of care between the CRA and taxpayers facing an audit.” That is, this was not a principal-agent relationship that required the former to indemnify the latter as a matter of common law. Indeed, Pardu cautioned that “[p]olicy reasons” favored rejecting such a duty as it “would expose the government to unlimited liability to a practically unlimited class: taxpayers.”

More to the point, when a taxpayer contested a sales tax audit, they were now taking an adversarial position against the government. As such, Pardu said that Jayco was not “acting as an agent of the tax authority” when it incurred interest and other legal costs related to that adversarial position. These costs were not incurred as part of the process of “collecting” sales tax.

S.M. Oliva is a writer living in Virginia. He authors the blog Computer Chronicles Revisited.
Teresa Farnsworth
Teresa Farnsworth

Teresa Farnsworth is the VP / Account Manager at Zip2Tax. She works closely with her clients to make sure they have just what they need to collect the right amount of sales or use tax in the U.S. and Canada. Questions? Chat with Teresa on the Web site, the Subscriber User Portal, or call her direct line; 866-492-8494.

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