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in Litigation

Federal government hits speedbump in lawsuit on smuggling

As widely reported in the media today, a U.S. district court judge has ruled in the tobacco industry’s favour and thrown out a Canadian government lawsuit with respect to an alleged conspiracy to smuggle cigarettes into Canada in the 1990s.

But contrary to what some commentators have suggested, the June 30th ruling by Judge Thomas J. McAvoy does not mean that the federal government has definitively lost its case. Indeed, McAvoy’s ruling may actually speed up the progress of the lawsuit through the courts.

McAvoy’s judgement is complicated, but the essential point is fairly simple. Under English common law, courts in one country should not be acting as tax collectors for another country — this is the common law Revenue Rule, which dates back to the 18th century. The Rule doesn’t stop two countries from signing a treaty that provides for the mutual enforcement of tax laws. Indeed, Canada and the United States do have an agreement on income tax, so that you can’t avoid paying a tax debt in one country simply by moving to the other. However, under the Revenue Rule, it is up to governments and legislatures, not courts, to decide what mutual enforcement arrangements are appropriate.

As it happens, the Revenue Rule has come under fire recently in the United States, with some scholars arguing that it is inappropriate in an increasingly globalized economy. Nor is the Revenue Rule accepted by all US courts.

However, according to Judge McAvoy’s decision, the Revenue Rule is accepted by the Second Circuit Court of Appeal, the federal appeals court that covers New York State. Since McAvoy is bound by precedents set by the Second Circuit, he says he has no choice but to throw out the Canadian government lawsuit.

Buried in the footnotes of McAvoy’s judgement is the following important comment:

Were the Court writing on a clean slate (which, as will be discussed, it is not), it would be inclined to find the Revenue Rule to be outdated (to the extent that it was ever properly recognized by courts in the United States in the first instance) and the rationales for the rule to be largely unpersuasive, at least with respect to the recognition of foreign tax judgements. (p. 13-14 of judgement).

In short, McAvoy clearly disagrees with the Second Circuit and thinks the Revenue Rule needs revisiting.

Law enforcement costs

The Canadian government’s statement of claim alleged more than just loss of tax revenue; it also points to the increase in law enforcement costs due to the alleged smuggling conspiracy.

On this point, McAvoy also hints broadly that he disagrees with the relevant Second Circuit precedents. After reviewing the case for and against counting law enforcement costs as damages to the Canadian government, he comments:

If the inquiry ended here, the Court would be inclined to allow Canada’s claims for law enforcement costs to proceed. However, the analysis of whether Canada sustained a cognizable injury to business or property under RICO [the Racketeer Influenced and Corrupt Organizations act] is complicated by the Second Circuit’s decision in Town of West Hartford(pp. 44-45 of the judgement)

Quick appeal?

Thus, McAvoy’s ruling could be interpreted as an invitation to the Canadian government to take these two points of law to the Second Circuit Court of Appeal, and as a respectful suggestion to the Second Circuit that it reconsider its views on the Revenue Rule and on increased law enforcement costs.

Further information

Please contact us by e-mail or phone if you need help in obtaining a full copy of the judgement.

See also: Tobacco suit far from over, Montreal Gazette, July 6th, 2000. [no longer available on-line]

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