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Taxation law

Taxpayer Awarded Millions in Damages for CRA's Unreasonableness and Inconsistency

Nov 1st, 2018

By Martin Bédard

In Ludmer v. Attorney General of Canada (2018 QCCS 3381; under appeal), the court applied Quebec civil-law notions of fault in granting a rare award for damages against the CRA ($4.8 million). The finding of negligence may be hard to reproduce in common-law provinces, where all similar claims have been rejected. In particular, Grenon v. Canada Revenue Agency (2017 ABCA 96; application for leave to appeal to the SCC dismissed) found that an action in negligence against the CRA for an auditor's conduct cannot succeed. 

The tax planning in question started in 1987, with the plaintiffs' investment into an offshore British Virgin Islands "fund of funds" held through a holding company ultimately named St. Lawrence Trading Inc. (SLT). As part of an effort to avoid the application of the 1999 proposed foreign investment entity rules (sections 94.1-94.4, proposed but never adopted), SLT was to own no assets other than equity-linked notes payable in 15 years ("the notes"), which would generate no revenue until their maturity. The intention was that the Canadian shareholders would defer any income until the notes were sold in 2016. The shareholders would also have a put option, exercisable at any time, to sell their shares in SLT before maturity, thus realizing a capital gain and not income. 

As part of the CRA's related-party initiative, the CRA took the position that the SLT shareholders should be taxed on deemed interest income on the notes further to section 94.1. Referring to regulation 7000, the CRA said that, in computing the deemed interest, "[t]he maximum amount of interest payable in respect of a year would be the difference between the maximum value of the Notes in the year and the maximum value in the prior year." 

The court agreed with the application of section 94.1, but it found the reassessments unreasonable. The use of the put option to determine annual accrual interest on the notes represented a significant break from the CRA's prior practice on equity-linked notes: "The CRA never suggested that the possibility of locking-in the bonus means that an amount can be accrued based on the highest value of the index in the year." 

After an extensive review, the court set out the standard of conduct that the CRA must meet in the course of an audit:

  • The CRA must act reasonably in the conduct of an audit. The Taxpayer Bill of Rights helps define what a reasonable auditor would do;
  • Negligence is sufficient to establish fault;
  • It is not necessary to prove that the CRA acted maliciously with a view to hurting the Plaintiffs. Intentional conduct will be necessary for punitive damages;
  • The CRA can be wrong without being at fault—the CRA does not commit a fault if it reasonably takes a position that turns out to be wrong;
  • To the extent that the CRA has certain powers under the ITA, it must exercise those powers reasonably and not in an abusive fashion.

In this case, the court found the CRA at fault in the following respects: 

Taking and clinging to unreasonable assessing positions and ultimately issuing unreasonable final assessments: the CRA's final assessing position was inconsistent with (1) prior and subsequent positions regarding equity-linked notes, (2) clear evidence in its denial of the application of the grandfathering coming-into-force rules on proposed section 94.1, and (3) the position of Rulings on the issue of the computation of foreign exchange. Further, it was unreasonable in including the increase in value of the notes in years prior to 2005 that were statute-barred.

  • Failing, before issuing the final reassessments, to give the taxpayer the promised prior notice, an explanation of the CRA's position, and an opportunity to rebut.
  • Referring to a "criminal tax matter" in a letter sent to the Bermuda tax authorities in order to obtain information about the taxpayers, when in fact the CRA was conducting only a regular audit.
  • Making a bad-faith settlement offer whereby the CRA offered to give up positions that it knew were unfounded in an attempt to extract as much tax as possible.
  • Providing incomplete responses to access-to-information requests.


This publication is of a general nature, is as of the date indicated and is not intended to constitute an opinion or legal advice.  The facts and circumstances of your particular situation should be specifically identified and addressed before appropriate legal advice may be given.