Finally, a judgment against CRA for negligence in audit of business

Court finds tax collector took certain positions for strategic reasons rather than good faith legal reasons. There will be an appeal

September 6, 2018

A Quebec Superior Court judgment awarding two Montreal businessmen nearly $5 million in damages against the Canada Revenue Agency (CRA) means taxpayers may have an easier time holding the tax collector accountable for its actions.

“This is probably the first case where CRA was found liable for having taken a position that they ultimately abandoned,” said Doug Mitchell of IMK LLP, the Montreal lawyer who successfully represented the plaintiffs Irvin Ludmer and the estate of the late Arnold Steinberg. “Normally, people are quite content if the Agency just walks away and leaves them alone.”

The 12-year-old saga began in 2006 with an audit of the businessmen’s offshore investment vehicle in the British Virgin Islands. The audit continued for six years, resulting in a $26 million reassessment in 2012.

Steinberg and Ludmer alleged that CRA had acted abusively, leading to the demise of their company. They sought $117 million in damages.

The case turned on “equity-linked notes,” which were attractive to investors because interest that accrued on them was not taxable until the notes matured.

“The problem for CRA was that the government was perfectly happy for institutions not to pay tax on these notes until they were realized, but were so motivated to go after my clients that they tried to make a specific rule for them,” Mitchell said. “It’s shocking and disturbing for tax authorities to single out a group of taxpayers for different treatment in a society governed by the rule of law.”

In the course of its audit, the CRA also wrongly suggested to Bermudan authorities that Ludmer and Steinberg were subject to criminal proceedings. As well, the Agency delayed in disclosing relevant documents to them.

“The court found that the CRA took certain positions for strategic reasons rather than good faith legal reasons,” says Martin Sorensen, a lawyer with Bennett Jones LLP in Toronto.

Still, Justice Stephen Hamilton, in his 148-page judgment issued on July 31, found that CRA had not acted maliciously. The Agency’s conduct, he ruled, was negligent and unreasonable but not intentional.

Hamilton concluded, however, that the absence of malice or intentional abuse did not absolve CRA from liability. He relied on provisions in Quebec’s Civil Code that requires parties to act reasonably and in good faith at all times.

“The common law courts in other provinces seem to have a more difficult time holding CRA liable because they don’t have similar statutory provisions on which they can rely,” Sorensen said.

But the Quebec ruling is in line with decisions from the Federal Court of Appeal and the British Columbia Court of Appeal, both released in 2016, which concluded that the CRA does have a duty of care to taxpayers.

A few months later, the Quebec Court of Appeal upheld a $2.4 million award, including $1 million in punitive damages, to a company destroyed by Revenue Québec’s abuse of power. Unlike that case, however, Hamilton’s decision is founded on CRA’s negligence, a much wider basis of liability than abusive or malicious conduct.

“Hamilton’s judgment represents a significant victory for taxpayers,” Sorensen said. “What’s really telling is the extent to which the court went into the details of the positions taken by CRA in order to determine whether these positions were unreasonable.”

For his part, Mitchell maintains that the court’s approach was too conservative.

“The one thing that made my jaw drop when we won was that we didn’t get punitive damages even though the judge found that CRA had subverted the tax system,” he said. “With the millions that were at stake for my clients as a result of CRA’s wrongful behaviour, the award of less than $5 million is too parsimonious.”

The taxpayers will appeal, seeking higher damages as well as punitive damages.

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