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Leroux: CRA owes duty of care to taxpayer

* This article was co-authored with Mr. Christopher Funt of Funt & Company.

Can a Canadian taxpayer successfully sue the Canada Revenue Agency?

In recent years, taxpayers have brought a number of civil actions against the Canada Revenue Agency (the “CRA”).  The allegations in such cases ranged from negligence to fraud, extortion and deceit.  Often, taxpayers’ claims are brought as the tort of misfeasance in public office or as claims in negligence.  So far, the courts have not clearly determined the scope of CRA’s civil liability.  The recent decision of the British Columbia Supreme Court in Leroux v. Canada Revenue Agency (2014 BCSC 720) provides guidance on the application of common law torts to CRA conduct.

Mr. Leroux, the taxpayer, alleged that he was threatened, deceived and blackmailed by a CRA auditor who was reviewing Mr. Leroux’s GST and income tax returns. After reassessments were issued, the CRA claimed Mr. Leroux owed more than $600,000 in taxes, interest and penalties. After an appeal to the Tax Court, some payments by Mr. Leroux and a successful application for interest relief, Mr. Leroux was actually refunded $25,000. In the meantime, Mr. Leroux lost his business and home. He sued the CRA for misfeasance in public office. The CRA argued that it owed no private law duty of care to an individual taxpayer.

In several other cases before Leroux, the courts have agreed with the CRA’s position. A successful negligence action requires a finding of a duty of care to the injured party.  As such, judicial acceptance of CRA’s position has presented a major barrier to bringing a civil claim against CRA.

In Leroux, the court splashed cold water on the CRA’s long-standing position and held the CRA did owe a duty of care to Mr. Leroux. The court also held the CRA had breached its duty of care to Mr. Leroux with respect to the imposition of gross negligence penalties. In a stinging rebuke to the case put forth by the CRA and its counsel, the court stated:

[348] To call Mr. Leroux’s tax characterizations “grossly negligent” is especially objectionable because, as mentioned above, CRA now uses the complexity of the issues involved in these characterizations as a reason why their decisions on exactly the same issue could never be termed negligent.  It is simply not logical for CRA to assess penalties against Mr. Leroux for being grossly negligent in having characterized his income in a particular way and to resist the application of the concept of negligence to their own characterization of the same income, one which was ultimately agreed to be wrong.  Or, to put it in the reverse, since CRA now takes the position that the characterization of capital loss versus revenue and the issue of “matching” are difficult and complex, it cannot be said that the assumption of contrary positions by Mr. Leroux, positions that were eventually accepted as correct, was grossly negligent.  To call them so, and to assess huge penalties as a result, ostensibly for the purpose of getting around a limitation period, is unacceptable and well outside the standard of care expected of honourable public servants or of reasonably competent tax auditors.  While being wrong is not being negligent, nor are [the auditor's] mistakes in fact or law negligent, it is the misuse and misapplication of the term “grossly negligent” that is objectionable.

The court continued:

[353] … CRA must live up to their responsibilities to the Minister and to the Canadian public, nearly all of whom are taxpayers, by applying a little common sense when the result is so obviously devastating to the taxpayer.  It is a poor response to say “we put together our position without regard to the law; leave it to the taxpayer to appeal to Tax Court because we are immune from accountability.”

Despite the finding that CRA owed a duty of care to Mr. Leroux, and that the CRA had breached this duty, the taxpayer’s claim was dismissed because the court held that Mr. Leroux’s losses were not the result of the CRA’s negligent conduct.

The Leroux judgment is a welcome development in the law regarding the CRA’s accountability for its assessing actions. Most CRA agents are diligent and very well-intentioned.  It is a rare case where the CRA’s conduct can properly be alleged to be actionable.  That said, the principles of civil liability shape what can and cannot be done by the CRA in the course of a tax assessment. While Leroux offers very insightful guidance, the broader scope of CRA’s civil law duties to taxpayers remains to be fully defined.

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Leroux: CRA owes duty of care to taxpayer

More on Rectification in Quebec

Rectification continues to be a topic of heated debate in Quebec. After a series of decisions by the Court of Appeal last year on the subject, the Quebec Superior Court rendered an important judgment on June 19, 2012 (Mac’s Convenience Stores Inc. v. Couche-Tard Inc., 2012 QCCS 2745) on a motion for declaratory judgment involving a well-known Canadian business.

This case is a reminder that rectification is not always available to correct errors made in the planning of a transaction, even if the unintended tax consequences result in a loss of several million dollars for a taxpayer.

The Facts

On April 14, 2005, Mac’s Convenience Store Inc. (“Mac’s”) borrowed $185 million from a U.S. corporation, Sildel Corporation (“Sildel”), which was a “specified non-resident” for purposes of the thin capitalization rules in subsection 18(4) of the Income Tax Act (the “Act”). Under this loan, Mac’s paid interest to Sildel ($911,854 in 2006, $11,069,590 in 2007, and $10,674,247 in 2008). These interest payments were deducted in computing the income of Mac’s for income tax purposes in the relevant years. This loan was fully repaid by Mac’s in 2008.

On April 25, 2006, Mac’s declared and paid a dividend of $136 million to Couche-Tard Inc. (“CTI”) out of its retained earnings. The decision to declare this dividend was taken after consultation with professional advisers.

More than 18 months later, it was discovered that the dividend of $136 million paid to CTI had the effect of raising the “debt” portion of Mac’s debt-to-equity ratio vis-a-vis Sildel for thin capitalization purposes beyond the then statutory limit of 2:1 under subsection 18(4) of the Act. In early 2008, Mac’s notified the CRA of the situation. After conducting an audit, the CRA issued notices of reassessment to Mac’s denying the deduction of all the interest it paid to Sildel during taxation years 2006, 2007, and 2008.

Mac’s filed a motion for declaratory judgment with the Quebec Superior Court requesting that the dividend of $136 million declared on April 25, 2006 and paid to the respondent CTI be cancelled retroactively and replaced by a reduction of Mac’s paid-up capital in the same amount. This rectification would have required no transfer of funds between the parties, but it would have allowed Mac’s to deduct the interest paid to Sildel in computing Mac’s income under the thin capitalization rules.

To read the full article, click here.

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More on Rectification in Quebec

Trust Me, This Isn’t What It Looks Like

Tax law geeks call it “form over substance” – how Canadians are taxed on their actual relationships and transactions rather than what they intended those to be.

However, mistakes can be made – and sometimes the tax assessed is not reflective of the true nature of the situation at hand.

In the March 16, 2012 issue of The Lawyers Weekly, I discuss the ways in which mistakes may be fixed so as to avoid unintended and adverse tax consequences.

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Trust Me, This Isn’t What It Looks Like

Brick Protection Corp. v. Alberta (Treasury) – Are Warranty Providers Subject to Insurance Corporation Tax Under Part IX of the Alberta Tax Act?

The Alberta Court of Appeal released its decision in this appeal on July 21, 2011.  Brick Protection Corp. (Brick Protection; now Trans Global Warranty Corp.) was a sister corporation of the Brick Warehouse Corp. (The Brick).  Brick Protection sold extended warranties to consumers on appliances and furniture purchased through The Brick.  The issue: Was Brick Protection Corp. doing business as an insurance company in Alberta?  If so, they would be subject to insurance corporation tax under Part IX of the Alberta Tax Act (the Act; now in the Alberta Corporate Tax Act).

For more on the decision of the Alberta Court of Appeal in Brick Protection Corp. v. Alberta (Treasury), read the commentary in FMC’s Focus on Tax.

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Brick Protection Corp. v. Alberta (Treasury) – Are Warranty Providers Subject to Insurance Corporation Tax Under Part IX of the Alberta Tax Act?