Executive Summary: Key Legal and Evidentiary Issues

• Zelkova Design Ltd. moved to strike four subparagraphs of the Crown's reply that referenced prior tax audits, criminal charges, and a conviction unrelated to the Appellant or the taxation years in dispute.

• Impugned subparagraphs risked inviting propensity reasoning and moral prejudice by associating the Appellant with the past conduct of Christine Giroux, who managed the Appellant, and Sylvain Giroux, its sole director.

• The Crown argued the subparagraphs were ministerial assumptions that had to be pled for full disclosure and were material to the issues, including penalties.

• Applying the "plain and obvious" standard under Rule 53(1)(a), the Court found the impugned allegations bore no direct connection to the Appellant's tax liability in the years under appeal.

• Distinguished from Heron, where criminal acts had a direct link to the tax non-compliance and penalty assessments, the historic Giroux matters (2006–2008) lacked any such nexus to Zelkova's disputed deductions.

• Motion granted: all four subparagraphs were struck without leave to amend, with costs in accordance with the Tariff.

Background of the dispute

Zelkova Design Ltd. is a company operating in the residential property development space. During the 2019 and 2020 taxation years, Christine Giroux managed the Appellant, her husband Sylvain Giroux was the sole director, and their son was the shareholder. Mr. Giroux was also the director of a related entity, SGR Design Ltd. The Canada Revenue Agency reassessed Zelkova's 2016, 2017, 2019, 2020, and 2021 taxation years. Deductions taken in the 2019 and 2020 taxation years were denied, penalties were assessed, and the 2019 taxation year was reassessed after the expiration of the normal reassessment period. The remaining years were reassessed for the resulting denial of loss carry-forwards and carry-backs. The largest denied deductions were in 2019, for management fees to SGR and a bad debt in connection with a related but defunct company, Lyons & Noble Developments Ltd.

The impugned subparagraphs and the Giroux history

In the Crown's reply, four specific subparagraphs drew the Appellant's objection. Subparagraph 9(i) stated that Christine and Sylvain were charged with tax evasion in 2014; subparagraph 9(j) stated that Christine pleaded guilty to two counts of tax evasion; subparagraph 9(p) noted that Lyon had previously been audited twice to deny personal expenses and to assess shareholder benefits; and subparagraph 10(o) alleged that as a result of one of the audits of Lyon, Christine was charged with tax evasion. According to the Giroux Affidavit, these matters related to a 2007 and 2008 audit of Lyons. Mrs. Giroux pled guilty to two counts of tax evasion, relating to unreported income for the 2006 through 2008 taxation years, and a small amount of unremitted GST/HST. According to the Giroux Affidavit, the fees to defend the charges were more than double the tax in issue. They could not afford the ongoing cost, and it did not seem economically worthwhile to continue. She pled guilty to two charges. Six others were dropped and the charges against Mr. Giroux were stayed, all as part of the plea deal.

The Appellant's arguments

Zelkova argued that the impugned subparagraphs colour the evidence and invite propensity reasoning, as though by association the Appellant is more likely to have improperly deducted expenses, although there seems to be no connection between the prior issues and the Appellant's dispute. The Appellant contended the allegations give rise to both moral prejudice and reasoning prejudice, casting the Appellant in an unfavourable light and encouraging the trial judge to give disproportionate weight to prior issues in the course of resolving the appeal. In support, the Appellant relied on Simard v The Queen, where the Court found that allegations concerning individuals charged with offences under the Criminal Code but not convicted could only serve to colour or taint the evidence to the respondent's favour. The Appellant also relied on Harris for the proposition that the Crown should not be permitted to rely on past criminal matters that were resolved with a plea bargain.

The Respondent's position

The Crown argued that the impugned subparagraphs were assumptions made in assessing the Appellant, and that they are material to the issues, including penalties. The Respondent further submitted that they had to be pled because of the Minister of National Revenue's responsibility to fully disclose the facts relied on when assessing, and that any concerns should be dealt with at trial — since a trial judge may be better positioned to determine whether the assumptions are material and relevant. The Respondent disputed the relevance of Simard, insofar as that case concerned "additional facts" rather than assumptions, which must be pled to ensure full disclosure of the assessing bases. The Crown also relied on Heron v R, describing it as a failed motion to strike similar assumptions, where the Court called the assumptions a complete and truthful disclosure of facts that the Minister relied on in assessing the taxpayer, and that they were relevant to the penalty assessment.

The Court's analysis on relevance and prejudice

Justice Sorensen applied the "plain and obvious" standard and assessed whether the impugned subparagraphs were relevant to the assessment of tax against the Appellant. The Court found it difficult to imagine any connection between the civil audit of Lyon, the stayed charges against Mr. Giroux, the plea bargain of Mrs. Giroux — all of which concern 2006 through 2008 — and the determination of liability of the Appellant in later years. Even if there was some connectivity between the historic events and the Appellant, charges not leading to a successful prosecution (Mr. Giroux), or a guilty plea under a negotiated resolution (Mrs. Giroux), are not facts entitled to significant weight as compared to a criminal matter determined on its merits. The Court further noted that Heron was distinguishable from the Appellant's case because, in Heron, the criminal acts had a direct link to the tax non-compliance and penalty assessments, whereas no such nexus existed here. On the issue of propensity reasoning, the Court found the impugned subparagraphs do risk colouring the evidence, as they suggest a tendency to mislead the revenue authorities and/or intimate bad character. This risk is acute where the allegations are that the Appellant made a misrepresentation when it filed its T2, and that it was grossly negligent. The probative value did not outweigh the prejudicial effect: the impugned subparagraphs risk significant prejudice without substantial probative value.

Ruling and outcome

The Court granted Zelkova Design Ltd.'s motion. Justice Sorensen ordered that subparagraphs 9(i), (j) and (p) and 10(o) of the Crown's reply be struck pursuant to Rule 53(1)(a), without leave to amend. The Court saw no point in permitting the Respondent to amend, concluding that variations on the same themes would not survive a future motion, and that judicial economy and fairness to the Appellant dictate that the tussle over the impugned subparagraphs be disposed of with finality. Costs will be in accordance with the Tariff. No specific monetary amount was ordered or awarded beyond costs on the Tariff, as this was a procedural motion to strike portions of a pleading rather than a determination of the underlying tax liability.