CRA Ordered to Pay $5 Million After “Unreasonable” Audit

August 23, 2018

written on behalf of Feigenbaum Law

The Canada Revenue Agency (CRA) was recently ordered to pay damages of almost $5 million after two men representing a group of taxpayers sued the agency claiming that the CRA engaged in “abusive” practices during an offshore tax audit which the men were caught up in.

In a lengthy decision supporting the damages order, the Quebec Superior Court admonished the CRA for a number of questionable practices that took place during the so-called “Billionaire’s Audit” in the mid-2000’s.

The Parties’ Business

The two men in question were long-time friends and business partners. They were early investors in hedge funds which, in the 1970’s, were cutting edge investment vehicles primarily based in the U.S and in offshore tax havens.

The men’s European based money manager suggested that the men create a new offshore fund. The men subsequently incorporated a company (GAMCAN) in the British Virgin Islands in 1987 with the purposes of investing in markets around the world. The men were the directors of the company. Shareholders were limited to 50 and restricted to residents of Canada.

GAMCAN was reorganized in 2001 under the new name SLT. The restructuring was intended to  defer Canadian tax for 15 years and result in capital gains rates on any accumulated income. SLT had about 160 shareholders (also all Canadian) and approximately $1 billion (USD) of assets under management.

Large Scale Audit of High-Net Worth Canadians

In 2005, the Canada Revenue Agency (CRA) announced the Related Party Initiative (RPI), more commonly known as the Billionaire’s Audit. The RPI targeted high-net worth Canadians who had been identified by the CRA as having paid relatively little tax.

One of the individuals targeted by the RPI was an SLT shareholder, thus bringing the company to the CRA’s attention. The CRA began an in-depth audit of SLT as well as a number of holding companies belonging to the two men and their family members. The audit began in 2006 and finished in 2012.

Following the audit, the CRA issued reassessments totalling more than $25 million in unpaid taxes, interest, and penalties. Provincial reassessments were also subsequently performed.

In 2014, the CRA abandoned and/or reversed many of these assessments.

The Lawsuit

The two men sued the CRA for more than $117 million in damages (including almost $40 million in punitive damages), claiming that the CRA’s conduct over the course of the lengthy audit was abusive and resulted in the failure of SLT. They argued that the CRA had taken the strongest possible assessing position in order to gain leverage for a possible settlement with the two men.

Regulation 7000

The court’s analysis revolved primarily around Regulation 7000 which provides for a deemed accrual of interest (which is then included as income) on “prescribed debt obligations”. The intention of this regulation is to ensure that taxpayers do not defer interest recognition (and therefore defer tax payment) until cash settlement.

The parties disputed which of the four categories outlined in the regulation applied in this situation, with the CRA taking the position that the Canadian based SLT shareholders were taxable on an annual basis, and the men arguing that the CRA had misapplied Regulation 7000 to deem income where there was none.

The court analyzed the reasonableness of the CRA’s assessing position in light of the statutory language as well as the past practices of the CRA and the Department of Finance.

The court noted that it would be fair to assume that when the men devised the SLT structure, they did so in order to obtain the benefit of the interpretation of Regulation 7000 that would allow them to defer tax (which was the CRA’s interpretation of the section for a relevant period of time).

The court further noted that the past practice of the CRA over a 20 year period was to permit entities structured like SLT to defer tax under Regulation 7000. The court went on to find that the CRA had therefore treated the men and SLT in a completely novel way that they had never treated other taxpayers and concluded that

…the CRA’s interpretation of Regulation 7000 is unreasonable given the clear break from past practice.

The Aggressive Tax Planning Division

In addition to finding that the CRA had acted inappropriately in applying Regulation 7000, the court also noted troubling actions on the part of the Aggressive Tax Planning Division which was heavily involved throughout the audit.

The Aggressive Tax Planning Division (ATP Division) is a compliance branch of the CRA devoted to identifying emerging tax avoidance issues. It has the power to administer special audit program for the CRA.

The ATP Division provided advice to the CRA and interacted with both the Department of Justice and the Department of Finance.

The court found, with respect to the ATP Division, that the Division had tried to “bully” the Income Tax Rulings Directorate (the branch of the CRA responsible for providing technical interpretation of the Income Tax Act and its Regulations) into issuing a specific interpretation of relevant regulations that was in line with the CRA’s overall position on SLT.

The court found that the ATP Division “…wanted…to have Rulings support their previous opinions” and when the Rulings Directorate did not do so they were “simply excluded from the process”.

The court noted that:

This is a very serious issue. If Rulings expresses reservations about a position, the ATP Division should act with caution. What it must not do is try to bully Rulings in order to maintain a particular position. This creates doubts as to whether the process, starting at the latest in June 2011, was led in such a way as to reach the right conclusion, or whether it was led in order to maintain a certain result.

The Court’s Conclusions

In addition to pointing out problems with the CRA’s deviance from past practices in interpreting Regulation 7000 and the ATP Division’s bullying tactics, the court also noted several other issues it had with the CRA’s approach to their audit of these taxpayers.

In the end, while the court admonished the CRA for these actions, it did not accept the argument of the two men that the CRA had acted maliciously, noting:

With respect to the reassessments, the Court concludes that the CRA officers involved believed that the SLT investments should be taxed and they were trying to find a basis on which to tax them. In the process, they ultimately took a position that the Court finds to be unreasonable. However, the reassessments were not issued maliciously in an attempt to harm [either of the two men]. As a result, the Court concludes that the CRA officers did not intentionally interfere with [the men’s] property rights. No punitive damages will be awarded for that fault.

The court awarded the men approximately $4.8 million intended to cover a portion of interest they had paid on taxes, part of the fees the men had expended on lawyers and other professionals, and $250,000 for “reputational loss, stress, trouble, and inconvenience.”

If you have questions about tax litigation, including litigation stemming from a CRA audit, reassessment or similar, contact Feigenbaum Law.  Our approach is always personalized. We take the time to understand the facts of your case to develop the best possible legal solution. We carefully consider all administrative solutions available to craft a response that proactively takes into account the policies and best practices of a given tax authority. Mark Feigenbaum  brings practical business knowledge, gained through roles in the entertainment industry, manufacturing, retail, public accounting and education, to all aspects of his law practice.

Contact us at, or call us at (416) 777-8433 or toll free at (877) 275-4792 to learn more about how we can help.


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