Commentary: Third-party litigation funding may provide ‘best of both worlds’ outcome in tax disputes

Covid-19 has affected the mining industry in unprecedented ways, ranging from forced mine shutdowns in some cases to profound fluctuations in supply and demand for various commodities. As the economy begins to reopen, preserving cash flow remains pertinent to the long-term health of mining companies, especially junior mining companies. Third-party litigation funding – that is, the financing of litigation by specialized parties that are not party to the litigation being funded – presents one opportunity to minimize expenditures and, by the same token, manage cash flow.

Beyond the usual disputes that are candidates for such arrangements, litigation funding presents an opportunity to manage the cost and risk of other disputes, such as those with tax authorities.

A litigation funding agreement typically provides that a litigation funder will agree to finance the cost of a litigation case, in full or in part, in exchange for an agreed share of the proceeds of the claim, if successful.

Traditionally, strict limits have been imposed on such arrangements. However, Canadian law has now evolved to allow greater scope and flexibility for these arrangements. Litigation funding has, as yet, mainly been relied upon in commercial litigation or arbitration cases, and appears never to have been used for tax disputes. However, the current context may be relevant to consider recourse to such an arrangement for tax disputes.

Disputes with Canadian tax authorities arise as a result of a myriad of events, only some of which involve the use of tax planning. More often, owing to the complex nature of tax laws, taxpayers and the government disagree on the permitted scope of taxing provisions, thus making it necessary to seek resolution before a court.

Mining companies are not immune to these disputes. In fact, a number of recent high-profile tax disputes have taken place in the mining industry.

For instance, Wesdome Gold Mines Ltd. successfully appealed a provincial reassessment that denied that expenses qualified as exploration expenses, but with the company having to endure an appeal by the government all the way to the Supreme Court of Canada. The recently settled dispute concerning Champion Iron’s Fermont facilities is an illustration of municipal governments putting into question the tax evaluation of mining facilities themselves. Finally, the federal government challenged Cameco’s method of determining the transfer price of uranium products, assessing the company with approximately an additional $160 million in taxes for 2003, 2005 and 2006.

Tax disputes can be notoriously complex to pursue, entailing high costs. Unlike conventional commercial disputes, tax disputes often have the added particularity that when a “large corporation” (one with total taxable capital employed in Canada at the end of the tax year of over $10 million) seeks to challenge the government’s position and the potential tax bill being disputed, it must prepay 50% of the disputed amount. Oftentimes, the entire amount is paid to avoid interest accumulation at exorbitant rates. Alternatively, if a corporation foresees that a dispute may arise, it will file its return accepting the government’s position and prepaying any amount of taxes in order to avoid the possibility of being charged penalties, and then it will challenge the tax treatment.

The scenarios discussed above result in situations in which a taxpayer is burdened with the payment of, or part of, the amount in dispute without having begun the lengthy dispute resolution process. In these circumstances, as well as those in which cash flow is an issue, litigation funding would allow a mining company to preserve and maintain cash flow that would otherwise be expended on the litigation process, without compromising effective legal representation or sacrificing necessary legal battles. This is particularly interesting considering that, in many cases, the outcome of a tax dispute for specific tax years has lasting consequences on the corporation’s future income tax payable.

Third-party litigation funding in the context of tax disputes is akin to the funding of commercial disputes. For litigation funders, tax disputes also present certain unique advantages. Among other things, (a) the defendant’s ability to pay is never at issue; (b) such litigation always leads to a monetary outcome; (c) tax litigation is less conducive to successful preliminary motions to dismiss, and no summary judgment rule exists; and (d) the Tax Court of Canada rules allow successful litigants to receive cost awards that can amount to a substantial portion of the litigation costs incurred.

As the government attempts to narrow the gap of the deficit generated by Canada’s Covid-19 Economic Response Plan, audit activity is likely to increase, making the situations described above more prevalent. Directors deciding which disputes to pursue and which to forgo should properly consider their fiduciary duties and their duty to act in the corporation’s best interests when making decisions to litigate. In certain contexts, third-party litigation funding may provide a perfect “best of both worlds” outcome, allowing even well-capitalized litigants to manage the cost and risk associated with tax disputes.

— Nathalie Goyette and James Trougakos are lawyers in the Montreal office of law firm Davies Ward Phillips & Vineberg.