When can a Canadian taxpayer seek punitive damage from the CRA?
Tax lawyer and accountant David Rotfleisch looks at the Quebec Court of Appeal case of Ludmer c. Attorney General of Canada
While Ludmer affirms that CRA owes a duty of care to taxpayers in auditing their taxes, it sets the standard for punitive damages very high under Quebec law, explains David J. Rotfleisch, CA, CPA, JD, of Rotfleisch & Samulovitch P.C.
Introduction – Negligence Lawsuits Against the CRA
The Income Tax Act grants the Canada Revenue Agency a broad range of powers and discretions when conducting tax audits of Canadian taxpayers. Some of these powers and discretions include making assumptions regarding the taxpayer's total income and tax liabilities without supporting documents, taking controversial legal positions on the interpretation of the Income Tax Act, as well as levying gross negligence penalties.
When the CRA exercises these powers in an unreasonable and negligent manner, it can cost Canadian taxpayers large amounts of legal and professional fees to respond to the tax audit. Canadian courts, Leroux v Canada Revenue Agency, have held that the CRA owes a duty of care to Canadian taxpayers. However, it remains to be seen to what extent Canadian taxpayers can claim damages against the CRA for wrongful conduct during a tax audit.
In the recent [May 28, 2020] Quebec Court of Appeal case Ludmer c. Attorney General of Canada, the taxpayers asked for over $117 million in damages, including $40 million in punitive damages, stemming from CRA's wrongful conduct in a tax audit conducted back in 2006. [In 2018], The Quebec Superior Court had already ruled in favor of the taxpayers but only granted the taxpayer $3.1 million in damages with no punitive damages. The taxpayers subsequently appealed the decision in order to be awarded the full $117 million.
Ludmer – The Facts
In the 1980s, the taxpayers, Irving Ludmer and Arnold Steinberg, invested in an offshore hedge fund company called Global Asset Management Ltd. In 1999, Global Asset Management Ltd. reorganized to ensure the newly formed entity named SLT held only note payables that matured in 15 years. This would allow SLT's Canadian shareholders to defer any taxable income until either they sold their shares or the notes matured. This tax reorganization was prompted by the Canadian Parliament's proposed rule change regarding offshore investment funds. Ludmer and Steinberg, as Canadian shareholders of SLT, reported their taxes to the CRA accordingly following the tax reorganization.
In 2006, the CRA commenced a tax audit against SLT's Canadian shareholders, including Ludmer and Steinberg, that lasted until 2012. The tax audit concluded with tax reassessments against the taxpayers for millions of dollars in tax liabilities. After an appeal to the Tax Court of Canada was filed by Canadian tax lawyers for SLT's Canadian shareholders, CRA abandoned their claims and vacated the tax reassessments.
Negligence and Damages claimed against the CRA
Irving Ludmer and Arnold Steinberg sued the CRA for negligence for its conduct during the tax audit. They sought damage payment over $117 million. Here is the breakdown of the categories of their damage claims:
- Lost interest on amounts paid pursuant to the tax reassessments
- Professional fees
- Compensatory damages to Ludmer and Steinberg's estate for reputational loss, stress, trouble, and inconvenience
- Compensatory damages for loss of future income
- Refund of tax paid
- Punitive Damages
Trial Judge ruling in Favor of Ludmer
The trial judge ruled that CRA had acted unreasonably in the following ways:
First, the CRA took an unreasonable position when determining the total sum payable by SLT.
Second, the CRA did not apply its own policy consistently when converting foreign currency to Canadian dollars during the tax audit.
Third, the CRA promised to give a five-day notice to the taxpayers before filing its tax reassessments but breached that promise.
Fourth, the CRA misrepresented the investigation as a criminal tax fraud investigation when communicating with the Bermuda tax authorities.
Fifth, the CRA only proposed an unreasonable settlement offer which they knew the taxpayers with advice from their experienced Canadian tax lawyers would reject.
Lastly, the CRA unduly delayed its production of information requested by the taxpayers under the Access to Information Act.
However, despite these findings of negligence, the trial judge only awarded the taxpayers lost interest on mandatory payments around 1.4 million dollars and 3 million dollars of the professional fees that were incurred before the commencement of the tax litigation. The trial judge considered the reputation damage to be minimal and only awarded $150,000 to the estates of Ludmer and Steinberg for reputation damages when the taxpayers requested an award of nine million dollars.
The trial judge did not award any damages related to loss of income. More importantly, the trial judge did not award any punitive damages because he did not find the CRA to have intentionally infringed the rights of the taxpayers.
Punitive Damages – Court of Appeal Decision
While the taxpayers appealed the entire trial court decision to the Quebec Court of Appeal regarding the denial of their damage claims, the most important issue for the case law on litigation regarding CRA's negligence is the Court of Appeal's decision regarding punitive damages.
It is first important to notice that a court's power to grant punitive damages is limited by any relevant provincial statutes. In this case Article 1621 of the Quebec Civil Code limits Quebec courts' ability to award punitive damages only when punitive damages are provided for by law. Therefore, the taxpayers had to ask for punitive damage based on section 49 of Quebec's Charter of Human Rights and Freedoms.
The appeals judge ruled that punitive damage can only be granted if the taxpayers can prove CRA officials acted intentionally to unjustly deprive and interfere with the taxpayers' property. The Supreme Court of Canada had already ruled that litigants can only claim punitive damage under section 49 of the Quebec Charter if there was unlawful and intentional interference on the part of a public body. Here, the appeal judge ruled that CRA's conduct must go beyond simple negligence for the taxpayers to be granted punitive damages. Thus, an individual official's recklessness, however wild and foolhardy, as to the consequences of his or her wrongful acts, will not in itself satisfy the standard for punitive damages.
At the trial level, the trial judge found CRA officials' testimonies to be credible enough to reject any conclusion that CRA intentionally deprived the taxpayers' property. The trial judge found CRA's intention during the tax audit was to assess tax, albeit the tax was assessed in an unreasonable manner. Furthermore, the trial judge did not find any intention on CRA's part to put SLT out of business. Subsequently, the appeal judge did not find any error in the trial judge's assessment of CRA's intentions. Therefore, the taxpayers' request for over 40 million dollars in punitive damages was denied.
While Ludmer affirms the law that CRA owes a duty of care to taxpayers in auditing their taxes, it sets the standard for punitive damages very high under Quebec laws. For Quebec taxpayers wishing to sue the CRA for punitive damages, they must go beyond establishing CRA's conduct was abusive and unreasonable. During the course of an audit, even when CRA acts in an unjust and unfair manner, more evidence regarding the intentions of the CRA officials will be needed in order to claim punitive damages against the CRA.
David J. Rotfleisch, CA, CPA, JD is the founding tax lawyer of Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law firm and is a Certified Specialist in Taxation Law. He appears regularly in print, radio and TV and blogs extensively. With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax litigation. Visit www.Taxpage.com and email David at email@example.com.