Ludmer c. Attorney General of Canada						2018 QCCS 3381
JH5439    SUPERIOR COURT
CANADA
PROVINCE OF QUEBEC
DISTRICT OF			MONTREAL
No:		500-17-076229-130
DATE:	July 31, 2018
PRESIDED BY:				THE HONOURABLE	STEPHEN W. HAMILTON, J.S.C.
IRVING LUDMER 3488055 CANADA INC. 3488063 CANADA INC. 3488071 CANADA INC. 2534-2825 QUÉBEC INC. 4077211 CANADA INC. 3421848 CANADA INC. 4431472 CANADA INC. MARK BRENDER, in his capacity as liquidator of the estate of the late Arnold Steinberg PHIL NADLER, in his capacity as liquidator of the estate of the late Arnold Steinberg MARGOT STEINBERG, in her capacity as liquidator of the estate of the late Arnold Steinberg DONNA STEINBERG, in her capacity as liquidator of the late Arnold Steinberg HABLAND INVESTMENTS INC. STONEVIEW INC. 3786986 CANADA INC. 4431481 CANADA INC.
Plaintiffs
v.
ATTORNEY GENERAL OF CANADA and CANADA REVENUE AGENCY
Defendants
JUDGMENT

INTRODUCTION

[1]          The Canada Revenue Agency (“CRA”) audited certain of the Plaintiffs in relation to their interests in an offshore investment vehicle. The audit lasted for several years before the CRA abandoned its position. The Plaintiffs allege that the conduct of the CRA in the course of the audit was abusive and caused the failure of the offshore investment vehicle and they sue the Defendants in Superior Court for over $117 million in damages.

CONTEXT

The Parties

[2]          Irving Ludmer and Arnold Steinberg were very successful businessmen. They met in the 1960s when both were working at Steinberg’s, a Montreal-based grocery chain owned and operated at the time by the Steinberg family. They became close friends and they invested together, including in the entity that became St. Lawrence Trading Inc. (“SLT”). Those investments are at the root of the present litigation. Steinberg[1] passed away on December 11, 2015, and the liquidators of his estate replaced him as Plaintiffs.

[3]          The other Plaintiffs are all holding companies belonging to Ludmer, Steinberg’s estate or members of their families:

·        3488055 Canada Inc., 3488063 Canada Inc., 3488071 Canada Inc., 2534-2825 Québec Inc., 4077211 Canada Inc. and 3421848 Canada Inc. (the “Ludmer SLT Plaintiffs”) are holding companies belonging to Ludmer or members of his family and were shareholders of SLT;

·        Habland Investments Inc., Stoneview Inc. and 3786986 Canada Inc. (the “Steinberg SLT Plaintiffs”; the Steinberg SLT Plaintiffs and the Ludmer SLT Plaintiffs together are the “SLT Plaintiffs”) are holding companies belonging to Steinberg’s estate or members of his family and were shareholders of SLT; and

·        4431472 Canada Inc. and 4431481 Canada Inc. belong to Ludmer and to Steinberg’s estate respectively and they received payments based on the amount invested by Canadian shareholders in SLT.

[4]          The Minister of National Revenue is charged with the administration and enforcement of the Income Tax Act (“ITA”).[2] The Minister is represented in this litigation by the Attorney General of Canada.

[5]          Finally, the Canada Revenue Agency (“CRA”) is empowered by statute to carry out responsibilities ascribed to the Minister, including the administration and enforcement of the ITA.[3]

The History of St. Lawrence Trading

[6]          First Steinberg in the 1960s and then Ludmer in the 1970s started to invest in hedge funds. Hedge funds were then cutting-edge investment vehicles, and the hedge funds of the day were based in the United States or in offshore tax havens.

[7]          In 1983, Ludmer and Steinberg met a European money manager named Gilbert de Botton. He was the co-founder of Global Asset Management Limited (“GAM”), which had an investment management business. GAM was incorporated in Bermuda and had subsidiaries and affiliates in the United Kingdom, Switzerland, the Isle of Man and Ireland. Ludmer and Steinberg were sufficiently impressed to invest funds with GAM.

[8]          In 1987, de Botton proposed to create a new offshore fund in which Ludmer and Steinberg, as well as other family members, foundations and friends, would become investors. He proposed to have this new fund spread the risk by outsourcing its clients’ holdings to several external business managers selected for their expertise and performance. This concept is referred to as a multi-manager fund or a “fund of funds”. Ludmer and Steinberg agreed.

[9]          As a consequence, GAMCAN Limited was incorporated in 1987 in the British Virgin Islands to invest in markets world-wide. Its shareholders were restricted to residents of Canada and were limited in number to 50. Ludmer and Steinberg’s investments with GAM were rolled into GAMCAN. GAMCAN was administered by a company within the GAM group.

[10]       Ludmer and Steinberg (either directly or indirectly through controlled corporations and related entities) were among the initial investors, along with members of other prominent Canadian business families. Ludmer and Steinberg were also directors of GAMCAN.

[11]       GAMCAN’s opening net asset value in 1987 was approximately US$65 million. Between 1987 and 1995, the initial shareholders increased their investments and some new investors subscribed for shares. This, combined with the performance of GAMCAN, resulted in GAMCAN’s net asset value increasing to approximately US$337 million in September 1994.

[12]       In November 1994, de Botton recommended that GAMCAN merge into GAM Multi-Global US$ Fund Inc. (“GAM Multi-Global”), another company incorporated in the British Virgin Islands managed by GAM with a similar investment policy and strategy which had offered its shares internationally. The directors of GAMCAN proposed to its shareholders that the merger was in their best interest, because of the similar investment policies and because the merger would allow participation in a more substantial company with a larger asset base that would have greater opportunity to access skilled investment managers and to diversify.[4]

[13]       As of September 30, 1994, the net asset value of GAMCAN was US$337,254,402 and that of GAM Multi-Global was US$267,491,723 with the result that the shareholders of GAMCAN would be issued 56% of the shares of the merged entity and the shareholders of GAM Multi-Global would be issued 44%.[5]

[14]       GAMCAM had a significantly lower fee structure than GAM Multi-Global, and one of the consequences of the merger was that all of the shareholders would pay the higher GAM Multi-Global fees. As described below, the additional fees paid by all of the GAMCAN shareholders were remitted to Sandringham Limited, a company controlled by Ludmer and Steinberg.

[15]       The merger was approved by the shareholders of the two companies on November 29, 1994 with effective date January 1, 1995. The merged entity changed its name to GAM Diversity Inc. in 1995.

[16]       GAMCAN and GAM Diversity did not pay any taxes in the British Virgin Islands. Moreover, GAMCAN and GAM Diversity generally did not pay dividends or otherwise distribute income to their shareholders with the result that their Canadian shareholders took the position that they were not required to pay any tax in Canada.

[17]       In the February 1999 federal budget, the government announced proposed foreign investment entity (“FIE”) rules in the ITA that would replace the current offshore investment fund (“OIF”) rules. The effect of the proposed FIE rules was to do away with the “motive test” under the current OIF rules and instead impute income on a taxpayer’s interest in an offshore entity that derived its value primarily from portfolio investments in listed passive properties.

[18]       There was a concern that the Canadian shareholders of GAM Diversity would be subject to substantial taxes on this undistributed income when the FIE rules came into force in 2001.[6] This would make GAM Diversity much less attractive to Canadian investors.

[19]       In anticipation of the adoption of the FIE rules, GAM Diversity proposed a reorganization as of November 30, 2001:

·        As a first step, the non-Canadian shareholders of GAM Diversity (representing approximately 45% of the total shareholdings) together with 45% of the assets of GAM Diversity were effectively rolled out of GAM Diversity and into a new GAM entity called GAM Global Diversity Inc., in what was essentially a reversal of the 1995 merger;

·        GAM Diversity was left with approximately 160 Canadian shareholders and approximately 55% of its assets;

·        GAM Diversity then sold its remaining assets to Scotiabank (Ireland) Limited (“SIL”) and TD Global Finance (“TDGF”), foreign subsidiaries of the Bank of Nova Scotia (“BNS”) and the Toronto Dominion Bank (“TD”), for an aggregate US$996 million;

·        GAM Diversity applied the proceeds from the asset sales to acquire two notes payable in 15 years (the “Notes”) issued by two other foreign subsidiaries of BNS and TD, Bank of Nova Scotia International Limited (Bahamas) (“BNSIL”) and Toronto Dominion International Inc. (Barbados) (“TDII”) and guaranteed by BNS and TD. The value at maturity of the Notes would be determined by reference to a pool of assets made up of the assets that were sold to SIL and TDGF or assets which replaced them (the “Reference Assets”);

·        BNSIL, SIL, TDII, TDGF and GAM entered into a management agreement appointing GAM as manager of the Reference Assets;

·        GAM Diversity was given the right to terminate the Notes at any time, on 367 days’ notice, at the market value of the Reference Assets;

·        The GAM Diversity shareholders were given the right to put their shares to SIL for a price equal to the proportionate share of the market value of the Reference Assets at the time of exercise of the put. BNS guaranteed SIL’s obligations under the put facility;

·        GAM Diversity changed its name to SLT.[7]

[20]       The purpose of this reorganization was to ensure that SLT held no assets other than the Notes and generated no actual revenue until the maturity of the Notes, with the intention that its Canadian shareholders would thereby defer any income until they sold their shares or until the Notes matured in 2016.[8] Further, the intention was that the shareholders would sell their shares in SLT immediately before maturity of the Notes, so that the gain on the Notes would be a capital gain and not income.

Sandringham, Thames Trust and Bloomsbury Trust

[21]       As mentioned above, one consequence of the 1995 merger of GAMCAN and GAM Multi-Global was that all of the shareholders would pay the higher GAM Multi-Global fees. According to the Plaintiffs, de Botton did not want this new fee structure to adversely impact his lead investors, Ludmer and Steinberg, and he therefore had GAM make payments to Sandringham, a company controlled by Ludmer and Steinberg through two offshore holding companies and two offshore trusts.[9] Through this structure, Ludmer and Steinberg received not only the additional fees that they themselves paid under the GAM Multi-Global fee structure, but also the additional fees that all of the other GAMCAN shareholders paid. Between 1995 and 2007, a total of over $100 million was paid to Sandringham.

[22]       In 2007, the structure was “Canadianized”.[10] The sums formerly payable to Sandringham were henceforth payable to Thames Trust, a Canadian trust of which 4431472 (Ludmer) was the beneficiary, and to Bloomsbury Trust, a Canadian trust of which 4431481 (Steinberg) was the beneficiary.[11]

[23]       The total amount received by Sandringham, Thames Trust and Bloomsbury Trust from 1995 to 2016 was almost $150 million.[12]

Taxes Paid

[24]       Ludmer and Steinberg and their holding companies (as well as the other SLT shareholders) took the position throughout the period starting in 1987 to the present that they did not owe any Canadian income taxes with respect to their investments in SLT and its predecessors.

[25]       They did not declare any income with respect to the predecessors of SLT for the period prior to the announcement of the proposed FIE rules in 2001 on the basis that the relevant test was the motive test and their motive for investing in GAMCAN was not to avoid tax but rather was to obtain the benefit of investment advice from the managers to whom GAM had access while they did not.

[26]       They did not declare any income with respect to SLT for the period after 2001 on the basis that the structure adopted by SLT was such that it did not have any income that could be attributed to its shareholders under the proposed FIE rules.

[27]       Ludmer and Steinberg and their holding companies also took the position that they did not owe any Canadian income taxes with respect to the sums received by Sandringham, Thames Trust or Bloomsbury Trust and distributed to them. The one exception to this is that, after the Sandringham structure was Canadianized in 2007, Thames Trust and Bloomsbury Trust declared the amounts that they received from GAM as income in their 2007 to 2010 tax returns, and 4431472 and 4431481 declared the amounts distributed by Thames Trust and Bloomsbury Trust as income in their 2008 to 2011 taxation years and paid taxes on those amounts.[13] Thames Trust and Bloomsbury Trust have since filed amended returns for the years 2007 to 2010,[14] and 4431472 and 4431481 have filed amended returns for the years 2008 to 2011 to claim the reimbursement of the taxes paid.[15] The CRA has not reimbursed the amounts claimed, despite numerous reminders.[16]

[28]       Ludmer and Steinberg did not declare any income with respect to Sandringham and they seek the reimbursement of the taxes paid by 4431472 and 4431481 between 2008 and 2011 on the basis that the fees were paid by GAM for the use of Ludmer and Steinberg’s names and reputations in inducing and retaining shareholder investment, and that such payments therefore lacked the quality of income and constituted instead non-taxable capital receipts.

[29]       Finally, Ludmer and his holding companies took the position from at least 1998 to 2007 that SLT and its predecessors were not their foreign affiliates or controlled foreign affiliates, and therefore they filed only the declaration that they held foreign property (Form T1135).[17]

[30]       Steinberg’s position is essentially the same. The only difference is that he and his holding companies recognized that SLT was their foreign affiliate (but not controlled foreign affiliate) and they filed Form T1134A.

The RPI Audit

[31]       In 2005, the CRA started the Related Party Initiative (the “RPI”), more commonly known as the Billionaire’s Audit. The RPI targeted a number of high wealth individuals identified by CRA headquarters who paid relatively little tax. The audits were carried out by auditors in the local tax services offices.

[32]       The RPI did not initially target Ludmer or Steinberg or SLT. However, one individual who was audited under the RPI was a SLT shareholder, and that is how SLT first came to the attention of the CRA in 2005.[18]

[33]       SLT was of immediate interest to the CRA because the taxpayer had elected to roll over his investment in SLT. He filed Form T2057 in which he declared that his SLT shares had a cost of $1,364,864 and a fair market value of $16,063,763.^[19] No tax had been paid on this very significant gain.

[34]       Preliminary research on SLT on the internet led to a filing in British Columbia relating to the reorganization of GAM Diversity which referred to 101 Canadian resident shareholders and $1 billion in assets,^[20] and financial statements of SLT as at December 31, 2002 which showed that it was an investment company incorporated in the British Virgin Islands, that it had assets of over US$1 billion and that it paid no taxes in the British Virgin Islands.^[21]

[35]       As a result, CRA began its audit of SLT sometime in 2006.[22] The CRA wanted to understand the SLT structure and the profits that it was earning, identify the other shareholders of SLT, and ensure that they were properly declaring their interest in SLT and their income from SLT.

Voluntary Disclosure by Ludmer

[36]       On June 19, 2008, before he was formally under audit, Ludmer sought to make a voluntary disclosure that four of his holding companies together held more than 10% of the outstanding shares of SLT such that SLT was their foreign affiliate, and to file the information returns relating to foreign affiliates (Form T1134A) for years 2001 to 2007.[23] They had previously filed only Form T1135 with respect to foreign property.[24] On September 16, 2008, Richter filed Form T1134A on behalf of 2862565 for 2002 and for 4077211 and 2534-2825 for 2002 to 2006.[25]

[37]        The CRA refused the voluntary disclosure on December 17, 2008.[26]

[38]       The CRA’s position was that the disclosure did not qualify as voluntary because it was initiated following an audit. Further, as the file progressed, the CRA came to the view that SLT was not only a foreign affiliate but was a controlled foreign affiliate such that Form T1134B was required. The CRA required Ludmer to file Form T1134B, which he did under protest on August 5, 2009 and November 5, 2009.[27]

[39]       The CRA threatened to charge Ludmer with gross negligence penalties totalling over $16 million with respect to the filing of Form T1135 instead of Form T1134B.[28]

[40]       The CRA abandoned its position on gross negligence penalties in December 2013.[29]

The Ludmer and Steinberg Audits

[41]       Ludmer was advised on January 9, 2009 that his 2005, 2006 and 2007 income tax returns had been selected for audit.[30] Steinberg was advised shortly thereafter that his 2005, 2006 and 2007 income tax returns had also been selected for audit.

[42]       On May 8, 2009, the CRA sent Ludmer a letter summarizing its position with respect to the Ludmer SLT Plaintiffs’ investments in SLT and in other foreign entities.[31]

[43]       The CRA applied the current OIF rules and not the proposed FIE rules which had yet to come into force. It took the position that Section 94.1 ITA and the motive test applied to 3488055, 3488063 and 3488071, for whom SLT was not a foreign controlled affiliate, and that the foreign accrual property income (“FAPI”) rules applied to 4077211, 2534-2825 and 34218148, for whom SLT was a controlled foreign affiliate.[32] The Court uses the expressions “non-CFA taxpayer” to describe a taxpayer for whom the foreign entity is not a controlled foreign affiliate, and “CFA taxpayer” to describe a shareholder for whom the foreign entity is a controlled foreign affiliate.

[44]       The result was that deemed interest in the total amount of $106,137.16 for the three years was attributed to each of 3488055, 3488063 and 3488071. The total FAPI to be added to the income of 4077211, 2534-2825 and 3421848 was later calculated to be almost $42 million for the years 2005 to 2007.[33]

[45]       The proposed reassessment letters sent to Steinberg on June 22, 2009 proposed to reassess Steinberg in respect of the Steinberg SLT Plaintiffs’ investments in SLT on the same basis, namely Section 94.1 ITA for the non-CFA taxpayers and FAPI for the CFA taxpayers.[34]

[46]       The CRA had taken the same assessing positions with respect to a number of other taxpayers who held shares in SLT or other offshore investment funds.[35] The CRA also declined settlement offers that involved selling the SLT shares and declaring a capital gain.[36]

[47]       There were many discussions, written submissions and meetings over the next three years between the CRA, Oslers on behalf of Ludmer and Steinberg and other counsel on behalf of other SLT shareholders. Counsel for the shareholders raised a number of issues, particularly relating to the CRA’s interpretation of Regulation 7000, which the CRA used to deem income to SLT. The CRA maintained its original positions throughout the audit, although the justification for the application of Regulation 7000 changed.

[48]       Further, on September 17, 2010, the CRA sent revised reassessments to the Ludmer SLT Plaintiffs^[37] and the Steinberg SLT Plaintiffs[38] in which it added secondary positions which did not rely on Regulation 7000 to impute interest income on the Notes but instead focused on the indirect holding of the Reference Assets. In addition, the CRA indicated that it was considering making an application under the general anti-avoidance rule (“GAAR”).

[49]       As the matter went forward, the CRA considered the proposed FIE rules, which were intended to replace Section 94.1 ITA and the motive test. Those rules were first proposed in 1999 and were carried forward from budget to budget but were never adopted by Parliament.[39] They were finally abandoned in the 2010 budget released on March 4, 2010.[40]

[50]       The coming-into-force (“CIF”) rules for the amendments included in the 2010 budget provided that a taxpayer who had voluntarily complied with the proposed FIE rules in previous years would be taxed under the proposed FIE rules.[41]

[51]       The CRA ultimately took the position that the CIF rules did not benefit the Plaintiffs.[42]

Protective Reassessments and Payments

[52]       While the audit was ongoing, the CRA requested and received waivers from several taxpayers when prescription periods were coming to an end.^[43] It issued protective notices of reassessment when the taxpayers refused to issue waivers or issued waivers that were declined by the CRA.

[53]       With respect to Ludmer SLT Plaintiffs, the CRA declined the waivers offered by 3488055, 3488063 and 3488071 for the 2005 taxation year and instead issued notices of reassessment on May 28, 2009.^[44] The notices of reassessment were based on the current OIF rules. The amounts at issue were relatively small. The total amount of the taxes payable pursuant to the three reassessments was $36,076.57.[45]

[54]       In the following year, 3488055, 3488063 and 3488071 did not provide waivers for the 2006 taxation year and the CRA issued notices of reassessment for 3488055, 3488063 and 3488071 for the 2006 taxation year on February 16, 2010, in the total amount of $45,880.76.[46]

[55]       Ludmer filed notices of objection with respect to the 2005 reassessments on August 25, 2009[47] and with respect to the 2006 reassessments on March 1, 2010.[48] At the same time, he paid in full and under protest the amounts of the reassessments.[49]

[56]       The CRA also issued the following notices of reassessment with respect to Steinberg and Habland:[50]

·        Notices of reassessment for Steinberg, for the 2005 ($8,935.69) and 2006 ($34,003.54) taxation years, on May 8, 2009 and May 21, 2010; and

·        Notice of reassessment for Habland for the 2006 taxation year in the amount of $360,531.03, on April 22, 2010.

[57]        Steinberg also paid in full and under protest the amounts of the reassessments.[51]

Final Reassessments

[58]       The CRA completed its audit in May 2012.[52]

[59]       It issued final reassessments with respect to the remaining SLT Plaintiffs for the remaining years between 2005 and 2010 in May 2012.[53] The total of the reassessments issued in 2012 was $25,950,627.78 in unpaid taxes, interest and penalties. Those reassessments were issued without any advance notice to the taxpayers. Provincial reassessments followed.

[60]       The CRA presented four assessing positions in the Auditor’s Report dated June 27, 2012[54] in support of the final reassessments, namely a primary and a secondary position for the non-CFA taxpayers and a primary and a secondary position for the CFA taxpayers.

[61]       The Plaintiffs objected to the notices of reassessment in August 2012.

[62]       The Plaintiffs nevertheless decided to pay in full and under protest the full amount of the reassessments.[55]

The Tax Court Proceedings

[63]       Two Ludmer SLT Plaintiffs filed notices of appeal to the Tax Court in connection with their reassessments for the 2005 taxation year, 3488063 on June 6, 2012, and 2534-2825 on October 12, 2012.[56]

The Bermuda Request

[64]       In 2012, the CRA was looking for additional evidence to support its position that Ludmer knew that SLT was a controlled foreign affiliate of certain of his related companies, in support of its position that Ludmer should pay substantial gross negligence penalties for his failure to file Form T1134B.

[65]       On August 9, 2012, the CRA wrote to the relevant authorities in Bermuda seeking to obtain information from Harbour Fiduciary Services Limited, the administrator of SLT, about the shareholders of SLT.[57] The CRA’s theory was that Harbour had information about the shareholders of SLT and that Ludmer had access to this information.

[66]       In the course of the exchanges with the Bermudan authorities, the CRA indicated that the request was in relation to a “criminal tax matter”.[58] This was not correct.

[67]       When the Bermudan authorities asked Harbour to deliver the information, they informed Harbour that the request was in relation to a “criminal tax matter”.[59]

[68]       Harbour thereupon notified the SLT shareholders of the request and the “criminal tax matter”.[60] Counsel to certain SLT shareholders other than Ludmer and Steinberg complained to the CRA on October 25, 2012 and demanded that the request be withdrawn.[61]

[69]       The CRA withdrew the request on October 30, 2012.[62]

[70]       The CRA apologized to the other SLT shareholders on November 22, 2012.[63]

[71]       Oslers complained about the situation on November 29, 2012[64] and the CRA apologized on February 19, 2013.[65]

The Access to Information Requests

[72]       While the audit was ongoing, Ludmer and Steinberg asked the CRA to provide information under the Access to Information Act (“ATIA”). The first request was made on August 19, 2009.[66] It was followed by five updated requests, each covering a longer period of time.[67] There were also requests with respect to Bermuda[68] and the “missing records”,[69] as described below, and two requests with respect to the CRA’s records relating to the ATIA requests.[70]

[73]       The two Ludmer SLT Plaintiffs with appeals pending in Tax Court also sought discovery in the Tax Court litigation.

[74]       The Plaintiffs complain that the answers provided by the CRA in both processes were late and incomplete and that repeated requests had to be made before information was finally provided. With respect to each request under the ATIA, the Plaintiffs made a complaint to the Office of the Information Commissioner with respect to the answers provided, and then sought judicial review by the Federal Court in relation to the report of the Information Commissioner. The details are set out in a table at Appendix 2 to this judgment.

[75]       The Plaintiffs also complained that the CRA had breached its pre-trial discovery obligations in the Tax Court proceedings. They sought a remedy under Rule 91(c) of the Tax Court Rules, which was refused by Justice Woods on July 22, 2015.[71]

The Sandringham Proposed Reassessments

[76]       The CRA first requested information about the payments to Sandringham on June 14, 2010.[72]

[77]       Oslers provided the information, including the fact that the payments totalled over $100 million, on November 25, 2010.[73] There was some correspondence back and forth through November 2012.[74]

[78]       Then, on May 16, 2014, the CRA sent letters to Ludmer and Steinberg in which it set out its proposed assessment in relation to Sandringham.[75] The CRA proposed to tax the payments to Sandringham as if they were income received by Ludmer and Steinberg. It proposed to tax the payments back to 1995 and to charge interest and gross negligence penalties. The total amount payable by each of Ludmer and Steinberg was approximately $130 million.

The Settlement Offer

[79]       A few days after the Sandringham proposed assessment, the Justice Department lawyer acting for the CRA in the Tax Court litigation wrote to Ludmer on May 27, 2014 with a settlement proposal.[76]

[80]       Essentially, Justice offered to apply the CIF rules for the taxation years ending prior to March 4, 2010 and to drop the gross negligence penalties on Sandringham if Ludmer agreed to pay the rest of the proposed reassessment on Sandringham and dropped the proceedings in Tax Court, Federal Court and Superior Court.

[81]       Ludmer did not accept the settlement offer.

Consent to judgment

[82]       When Ludmer did not respond to the settlement offer within the time specified, Justice advised the Tax Court on May 30, 2014 that it would consent to judgment in the two pending appeals.[77]

[83]       The SLT Plaintiffs contested Justice’s right to consent to the two appeals.[78] On June 19, 2014, the remaining SLT Plaintiffs filed appeals for the remaining tax years.[79]

[84]       On October 6, 2014, the Tax Court consolidated all of the appeals and then allowed them all by consent. The result was that all of the reassessments for taxation years ending prior to March 4, 2010 were vacated.[80]

[85]        All of the amounts paid by the Ludmer SLT Plaintiffs pursuant to the reassessments were refunded to them in November 2014, with interest at 1%.[81] The amounts paid by Steinberg and his companies pursuant to the reassessments were refunded to them in March and April 2015, with interest at 1%.[82]

Current status

[86]       As a result of all of the foregoing, there are currently only three appeals outstanding, by three Ludmer SLT Plaintiffs (3488055, 3488063 and 3488071), with respect to the 2010 taxation year. The amounts at issue total approximately $225,000.[83]

[87]       The Sandringham issues have not been resolved. The CRA’s latest proposal to reassess dated June 22, 2016 maintains the earlier position, adds additional grounds and adds two more years of interest to increase the amount at issue to approximately $275 million.[84] The Plaintiffs responded on August 11, 2016.[85] The Plaintiffs are still seeking the reimbursement of the taxes paid on the Canadianized structure between 2008 and 2011.[86]

[88]       Meanwhile, the shareholders of SLT, including the Plaintiffs, have exercised their put options and sold their shares, and SLT has essentially ceased its operations.

THE TRIAL

[89]       The trial lasted four months.

[90]       The Plaintiffs called only two ordinary witnesses, Ludmer and Mark Brender, one of his tax attorneys from Oslers.

[91]       Given the number of witnesses called by the Defendants from the CRA as well as from the Finance and Justice Departments, it is important to describe how the CRA is structured, its relationship with Finance and with Justice and the role that each witness played.

The CRA

[92]       The CRA is tasked with the administration and enforcement of the ITA.

[93]       The CRA is made up of 12 headquarters branches, including five program branches, and five regional administrations.[87]

[94]       Those relevant to the present matter are described below.

1.    Montreal Taxation Services Office

[95]       The Ludmer and Steinberg audits were performed in the Montreal Taxation Services Office (“TSO”).

[96]       The Montreal TSO is a tax service office within the Québec Regional Administration.

[97]       Ginette Phisel and Pierre Leduc were auditors in the Montreal TSO and they were each assigned one taxpayer to audit in the context of the RPI. SLT first came to their attention in 2005 in the context of those initial audits under the RPI. The Montreal TSO was in charge of the SLT audits, including the Ludmer and the Steinberg audits, from 2005 until it issued final reassessments with respect to the remaining Plaintiffs for the remaining years between 2005 and 2010 in May 2012,[88] or its Auditor’s Report on June 27, 2012.[89]

[98]       Phisel and Leduc were the officers who carried out the SLT audit in the Montreal TSO. Both testified at the trial. Bernard Benedetti was their team leader in 2005 when SLT first came to their attention. He retired in March 2008 and was replaced by Joseph Armanious. Armanious was very involved in the Ludmer and Steinberg audits, but he did not testify at the trial. The reasons for not calling him were never disclosed to the Court.

[99]       Claudio Ordonselli is the auditor and Jeffrey Zucker the team leader at the Montreal TSO in charge of the Sandringham audit. Zucker testified at the trial.

2.    Aggressive Tax Planning

[100]    The Aggressive Tax Planning (“ATP”) Division is a division within the Compliance Programs Branch at CRA headquarters. The ATP Division identifies emerging tax avoidance issues, arrangements and products, and it handles cases requiring a remedy for tax avoidance. It also has the mandate to apply GAAR, and to administer special audit programs for the CRA.

[101]    Phisel initially contacted the ATP Division on June 6, 2006 in order to seek technical assistance on the application of Section 94.1 ITA to the SLT structure.[90] The ATP Division remained very involved in the file until the end, providing advice to the Montreal TSO and interacting with the other branches and divisions of the CRA as well as with Justice and Finance.

[102]    François Ranger was the Director of the ATP Division, Lynda Gibson was a manager in the Non-Resident Trusts and Foreign Investment Entities Section, and Stéphane Charette was an Offshore Trust & Foreign Investment Entity Officer. All three were involved with the Ludmer and Steinberg audits and all three testified at the trial.

[103]    Dawn Dannehl was the ATP Division officer who provided input in the Sandringham audit. She testified at trial.

3.    Rulings

[104]    The Income Tax Rulings Directorate is within the Legislative Policy and Regulatory Affairs Branch at CRA headquarters. Rulings’ mandate is to provide the CRA's technical interpretation of the ITA, the Income Tax Regulations and related statutes including Income Tax Conventions and to issue advance income tax rulings and technical interpretations.

[105]    Rulings was divided into four Divisions, Reorganizations, Business and Employment, International and Trusts, and Financial Sector and Exempt Entity.[91] The latter two divisions were involved in SLT.

[106]    Wayne Adams was the Director General of Rulings until his retirement on September 30, 2011. He was succeeded by Phil Jolie, who had been the Director of the International and Trusts Division. Sherry Thomson was an officer and later an acting manager and Olli Laurikainen was a manager in the International Section of the International and Trusts Division. Claude Tremblay was an officer and Roberta Albert was a manager in the Corporate Financing Section of the Financial Sector and Exempt Entity Division. The Director of the Financial Sector and Exempt Entities Division was Mark Symes.[92]

[107]    The Rulings Directorate issued a total of six technical interpretations relating to different aspects of the SLT matter:

1.    TI 2007-022652 dated July 18, 2007 drafted by Thomson and signed by Laurikainen (the “First TI”);[93]

2.    TI 2008-025424 dated January 15, 2008 drafted by Tremblay and signed by Albert (the “Second TI”);[94]

3.    TI 2008-026588-1 dated May 27, 2008 drafted by Thomson and signed by Laurikainen (the “Third TI”);[95]

4.    TI 2008-026588-2 dated May 27, 2008 drafted by Thomson and signed by Laurikainen (the “Fourth TI”);[96]

5.    TI 2009-033131 dated June 29, 2010 drafted by Tremblay and signed by Albert (the “Fifth TI”);[97] and

6.    TI 2010-039121 dated April 8, 2011 drafted by Thomson and signed by Laurikainen (the “Sixth TI”).[98]

[108]    In addition, Adams, Jolie and Symes were involved at the level of the GAAR Committee and in various meetings and correspondence with Ludmer and Steinberg’s counsel.

[109]    All of the individuals mentioned above testified at the trial.

4.    GAAR Committee

[110]    The ATP Division applied to the GAAR Committee on September 7, 2010 for a ruling that GAAR applied to SLT.[99] The GAAR Committee met twice in relation to SLT.

[111]    The GAAR Committee was made up of senior officials from the different directorates of the CRA, as well as officials from the Finance and Justice Departments.

[112]    Many of the participants in the meetings testified at the trial, including Adams, Jolie, Symes, Phisel, Gibson, Charette, Thomson, Albert, Tremblay, and Grant Nash of the Finance Department.

5.    Competent Authority Services

[113]    The Competent Authority Services Division is another division within the Compliance Programs Branch at headquarters. It is designated as the “competent authority” in Canada under the various tax treaties to which Canada is a party. As such, it is the sole party entitled to communicate with foreign tax authorities under tax conventions and tax information exchange agreements.

[114]    In relation to SLT, the Competent Authority Services Division made various requests for information from foreign taxation authorities, including the problematic request to the taxation authorities in Bermuda.

[115]    Sue Murray, the Director of the Competent Authority Services Division, and Luc Rochefort, the officer in the Exchange of Information Services division who prepared the Bermuda request, both testified at the trial.

6.    Access to Information and Privacy Directorate

[116]    The Access to Information and Privacy (“ATIP”) Directorate is a directorate within the Public Affairs Branch at headquarters.

[117]    The ATIP Directorate supports the CRA in meeting its requirements under both the ATIA and the Privacy Act.[100]

[118]    Gilles Vallée was a project coordinator in the ATIP Directorate assigned to the Montreal TSO. He was in charge of preparing the CRA’s responses to the various Access to Information requests made by Ludmer. After Vallée’s retirement in 2011, he was replaced by Mark Fidanza. Fidanza testified at the trial.

7.    Appeals Branch

[119]    The Appeals Branch is another branch of the CRA at headquarters.

[120]    Its mandate is to provide a fair and impartial process to administratively resolve tax disputes before going to court.

[121]    Chantal Faubert of the Appeals Branch testified as to the closing of the various files in 2014.

Finance Department

[122]    The Finance Department is responsible for Canadian tax policy. It determines what conduct should be incentivized and what conduct should be discouraged from a tax perspective, and ensures that the proper functioning of the economy is not unduly affected by taxation law. It proposes amendments to the ITA to achieve outcomes consistent with that policy.

[123]    Finance became involved in this matter because of concerns as to whether applying Regulation 7000 to derivatives was consistent or not with Canadian tax policy and whether it ran counter to former pronouncements of the Finance Department.

[124]    It was also involved in the interpretation of the CIF rules.

[125]    Grant Nash and Tobias Witteveen from Finance testified at the trial.

Justice Department

[126]    The Justice Department played two roles in this matter: it provided legal advice to the CRA during the audit, and it represented the CRA in the ensuing proceedings in Tax Court, in the Federal Court and in the present matter.

[127]    The communications between Justice and the CRA in relation to the legal advice given by Justice in the course of the audit and the proceedings are privileged and therefore were not produced in the court record. The Court is therefore left with a limited picture of the legal advice that the CRA received and acted on.

[128]    Me Marie-Andrée Legault testified with respect to certain aspects of the Tax Court proceedings.

Experts

[129]    Finally, both sides called experts to testify as to the calculation made by the Plaintiffs of the value of their lost income related to SLT. Renata Milcarek testified for the Plaintiffs and Alain Viger testified for the Defendants.

ISSUES

[130]    Based on the foregoing, the Court has identified the following issues:

A.     What is the standard of conduct that the CRA must meet in the course of an audit?

B.    Did the CRA commit a fault with respect to the following:

1.    Refusing Ludmer’s voluntary disclosure and threatening to assess gross negligence penalties;

2.    Failing to move the matter forward expeditiously;

3.    Taking and clinging to unreasonable assessing positions and ultimately issuing unreasonable final assessments;

4.    Failure to give the promised prior notice, explanation of the CRA’s position and opportunity to rebut before issuing the final reassessments;

5.    Referring to a “criminal tax matter” in a letter sent to the tax authorities in Bermuda;

6.    Issuing unreasonable draft reassessments with respect to Sandringham;

7.    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; and

8.    Providing incomplete responses to Access to Information requests.

C.    If the CRA committed a fault, is it responsible for the following remedies:

1.    Reimbursement of lost interest on the amounts paid pursuant to the reassessments;

2.    Reimbursement of professional fees incurred in connection with the audit and in all of the related proceedings in Tax Court, before the Information Commissioner and in Federal Court;

3.    Damages for reputational loss, stress, trouble and inconvenience;

4.    Damages for lost income related to SLT;

5.    Stay of the Sandringham reassessments and refund of the amounts paid by 4431472 and 4431481; and

6.    Punitive damages.

ANALYSIS

A.   Standard of Conduct

[131]    The parties take different positions on the standard of fault that applies in this matter.

[132]    The Plaintiffs argue that the applicable standard is the general notion of civil fault under Article 1457 of the Civil Code of Québec (“C.C.Q.”) and that the Defendants therefore commit a fault if they fail to meet the standard of the reasonably competent tax auditor. The Plaintiffs also argue that their claim is based in part on the notion of abuse of rights.

[133]    The Defendants, on the other hand, argue that the case is framed in terms of abuse of power/rights such that the Defendants are only liable if they (1) intended to cause harm to the Plaintiffs or (2) were reckless in that regard. They argue that this is similar to the common law notion of misfeasance in public office.

[134]    As this is a claim against the federal Crown and its representatives, the starting point in the analysis is Section 3(a) of the Crown Liability and Proceedings Act:[101]

3 The Crown is liable for the damages for which, if it were a person, it would be liable

(a) in the Province of Quebec, in respect of

(i) the damage caused by the fault of a servant of the Crown, or

(ii) the damage resulting from the act of a thing in the custody of or owned by the Crown or by the fault of the Crown as custodian or owner;

[135]    This means that the general principles of civil liability applicable to private persons under Québec law also apply to the actions of the federal Crown in Québec.

[136]    This is confirmed by Article 1376 C.C.Q., which provides that the rules in the book on obligations apply to the State:

1376. The rules set forth in this Book apply to the State and its bodies, and to all other legal persons established in the public interest, subject to any other rules of law which may be applicable to them.

[137]    In principle, then, the general notion of civil fault under Article 1457 C.C.Q. applies to the federal Crown:

[25]       Civil liability of the federal Crown for wrongful acts of its agents is governed by the law of the jurisdiction where the acts were committed. In Quebec, the combined effect of the Crown Liability and Proceedings Act and the relevant provisions of the Civil Code of Québec is that the federal Crown is subject to the rules respecting civil liability set out in art. 1457 C.C.Q.[102]

[138]    The first paragraph of Article 1457 C.C.Q. provides as follows:

1457. Every person has a duty to abide by the rules of conduct incumbent on him, according to the circumstances, usage or law, so as not to cause injury to another.

[139]    This means that in principle, the CRA commits a fault if it does not meet the standard of a reasonable person in similar circumstances.

[140]    The Alberta Court of Appeal recently held that the CRA cannot be sued for negligence in the performance of an audit:

[25]       In our view, it is plain and obvious that an action in negligence cannot succeed. It is clear that, because of the inherently adverse relationship between auditors who are exercising a statutory function and taxpayers, a finding of sufficient proximity to ground a private law duty of care does not exist. The chambers judge correctly applied the Cooper-Anns test and considered foreseeability and proximity to reach the same conclusion. Not only is her decision entitled to deference, the chambers judge could have gone further to conclude that public policy considerations also militate against finding the existence of a prima facie duty of care in this case.[103]

[141]    However, this decision is based on common law notions of duty of care, proximity, foreseeability and public policy that have no application in Québec.

[142]    Article 1376 C.C.Q. recognizes that the application of the general rules of civil liability to the Crown is subject to rules of public law. These rules of public law may either prevent the general rules of civil liability from applying to the Crown or substantially alter how they are applied. Certain statutes, for example, give the Crown or a public body a general or a more limited immunity in certain circumstances.[104]

[143]    Section 8 of the Crown Liability and Proceedings Act provides such a limited immunity:

8 Nothing in sections 3 to 7 makes the Crown liable in respect of anything done or omitted in the exercise of any power or authority that, if those sections had not been passed, would have been exercisable by virtue of the prerogative of the Crown, or any power or authority conferred on the Crown by any statute, and, in particular, but without restricting the generality of the foregoing, nothing in those sections makes the Crown liable in respect of anything done or omitted in the exercise of any power or authority exercisable by the Crown, whether in time of peace or of war, for the purpose of the defence of Canada or of training, or maintaining the efficiency of, the Canadian Forces.

[144]    The Supreme Court has held that this immunity is limited to true core policy acts.[105]

[145]    Moreover, even in cases where an immunity is available if the Crown or public body acts in good faith, it does not protect the Crown where the plaintiff demonstrates bad faith on the part of the Crown or public body, as that term is broadly defined by the Supreme Court in Hinse:

[53]         In sum, decisions of the Minister that are made in bad faith, including those demonstrating serious recklessness — as defined in Finney and Sibeca — on the Minister’s part, fall outside the Crown’s qualified immunity. Bad faith can be established by proving that the Minister acted deliberately with the specific intent to harm another person. It can also be established by proof of serious recklessness that reveals a breakdown of the orderly exercise of authority so fundamental that absence of good faith can be deduced and bad faith presumed.[106]

[146]    In the present matter, the Plaintiffs are suing the CRA for its behaviour in the conduct of an audit. This is not a true core policy act. The CRA is not charged with exercising a legislative or regulatory power or setting tax policy - those are matters for the Finance Department. The CRA’s role is limited to collecting the tax that is due under the ITA. The Court concludes that the CRA cannot claim any immunity and it is subject to the regular civil standard of fault.

[147]    There is also the argument that where the public authority is given a discretionary power, it is only liable if it abuses that power. The CRA does not generally exercise discretionary powers - its mandate is to calculate the tax due, no more and no less. However, it may exercise discretionary powers when it decides, for example, to issue a demand for information.

[148]    The Québec Court of Appeal applies both the notions of failing to meet a standard of conduct and abuse of discretionary powers in dealing with the liability of the Agence du revenu du Québec in its recent decision in Groupe Enico:

[107]     Ainsi, si le vérificateur ou le percepteur d’impôt ne respecte pas les obligations professionnelles, déontologiques et éthiques qui lui incombent, dont l’obligation d’agir avec transparence et honnêteté, ne respecte pas le devoir qui impose à tout fonctionnaire d’agir équitablement ou s’il abuse de ses pouvoirs discrétionnaires, l’ARQ pourrait devoir indemniser le contribuable à qui ces agissements causent préjudice. C’est à ce niveau que se situent les enjeux du présent dossier.

[108]     La mission première de l’ARQ est d’assurer la perception des impôts et des taxes, afin que chacun paie sa juste part du financement des services publics. L’ARQ administre aussi les programmes sociofiscaux et tout autre programme de perception et de redistribution de fonds que lui confie le gouvernement.

[109]     L’ARQ bénéficie de pouvoirs que l’on peut sans peine qualifiés d’exorbitants et il y a certainement une justification raisonnable pour que de tels pouvoirs lui soient confiés. L’ampleur du phénomène du « travail au noir » et l’objectif visant l’atteinte de l’équité fiscale entre les citoyens justifient que le législateur confère de tels pouvoirs qui, rappelons-le, imposent un lourd fardeau au contribuable. Les lois fiscales lui imposent notamment : 1) l’autodéclaration et l’autocotisation; 2) l’obligation de donner aux vérificateurs accès à ses bureaux et ses livres, ainsi que celle de répondre à leurs questions; 3) le fardeau de contrer la présomption de validité des avis de cotisation; 4) le devoir d’acquitter sans délai, même en cas de contestation, les sommes réclamées par un avis de cotisation; 5) l’obligation de faire face au statut avantageux de l’ARQ en cas de faillite, ainsi qu’aux facilités de saisie; et 6) le devoir de s’incliner devant le pouvoir de l’ARQ d’utiliser la compensation à son avantage, pour ne nommer que ceux-là.

[110]     En contrepartie, des responsabilités accrues s’imposent à l’ARQ, en proportion des pouvoirs ainsi délégués. Plus une agence gouvernementale possède de pouvoirs exorbitants, plus elle risque de causer un préjudice au contribuable si elle les exerce de façon abusive, déraisonnable ou sans considération pour les conséquences qui peuvent en découler.

[111]     Un devoir de prudence et de bonne foi dans l’exercice de ces pouvoirs s’impose naturellement. Si elle se dérobe à ce devoir, l’ARQ ne doit pas s’étonner que les tribunaux, eux aussi soucieux du bien public, jugent avec sévérité son manque de rigueur. C’est ce qui s’est produit dans le présent dossier.

…

[114]     S’affrontent ici deux impératifs : d’un côté, l’efficacité dont l’ARQ doit faire preuve pour accomplir sa mission qui est de percevoir les impôts et taxes de chacun de façon à assurer l’équité fiscale entre les contribuables, et, de l’autre, le respect de ses propres règles et directives, son devoir d’agir équitablement et ne pas abuser des puissants instruments mis à sa disposition. On ne saurait nier que le mariage ou la mise en balance de ces deux impératifs puisse parfois être difficile.[107]

[Emphasis added]

[149]    As for “le respect de ses propres règles et directives”, the Court of Appeal in Groupe Enico referred to Revenu Québec’s Déclaration de services aux citoyens et aux entreprises. The equivalent for the CRA is the Taxpayer Bill of Rights:

1. You have the right to receive entitlements and to pay no more and no less than what is required by law

2. You have the right to service in both official languages

3. You have the right to privacy and confidentiality

4. You have the right to a formal review and a subsequent appeal

5. You have the right to be treated professionally, courteously, and fairly

6. You have the right to complete, accurate, clear, and timely information

7. You have the right, unless otherwise provided by law, not to pay income tax amounts in dispute before you have had an impartial review

8. You have the right to have the law applied consistently

9. You have the right to lodge a service complaint and to be provided with an explanation of our findings

10. You have the right to have the costs of compliance taken into account when administering tax legislation

11. You have the right to expect us to be accountable

12. You have the right to relief from penalties and interest under tax legislation because of extraordinary circumstances

13. You have the right to expect us to publish our service standards and report annually

14. You have the right to expect us to warn you about questionable tax schemes in a timely manner

15. You have the right to be represented by a person of your choice

16. You have the right to lodge a service complaint or request a formal review without fear of reprisal[108]

[150]    Moreover, the CRA’s role is limited to matters of administration and enforcement. Its duty is to assess no more and no less than the amount of tax payable under the ITA, and not to take the highest assessing position in order to collect the most tax. As stated by the Federal Court of Appeal in Harris v. Canada:

[36]       Revenue Canada is vested with no such powers. In Ludmer v. Canada, this Court held that the powers provided to the Commissioners which were at issue in the National Federation of Self-Employed case are "fundamentally different" from the powers of the Minister in Canada:

Neither the Minister of National Revenue nor his employees have any discretion whatever in the way in which they must apply the Income Tax Act. They are required to follow it absolutely, just as taxpayers are also required to obey it as it stands. The institution of Commissioners equipped with broad powers and an extensive discretion to deal with particular cases does not exist here. Accordingly, it is not possible to judge their actions by varying and flexible criteria such as those required by the rules of natural justice. In determining whether their decisions are valid the question is not whether they exercised their powers properly or wrongfully, but whether they acted as the law governing them required them to act.[109]

[References omitted]

[151]    The Court therefore concludes as follows on the issue of the standard of conduct:

·                     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;

B.   Alleged Faults

[152]    Ludmer and Steinberg alleged a series of faults against the Defendants.

1.    Refusing Ludmer’s voluntary disclosure and threatening penalties

[153]    The CRA filed in the Court record the information returns relating to foreign property filed by the Ludmer SLT Plaintiffs for each year from 1998 to 2011.[110]

[154]    Prior to 2008, the Ludmer SLT Plaintiffs only filed Form T1135 with respect to their investments in SLT.[111]

[155]    Form T1135 showed the following:

·        The name SLT was not disclosed;

·        3488055, 3488063 and 3488071 checked the box that the cost of their investment was between $700,000 and $999,999, while 2534-2825 and 4077211 (and 2862565 Canada Inc. in 1999-2003) checked the box that the cost of the investment was greater than $1 million;

·        The investment was shown as located in the U.K. in 1998-2000 and in Europe other than U.K. starting in 2001; and

·        The income was zero.

[156]    During this same period, the Steinberg SLT Plaintiffs filed Form T1134A with respect to their shares in SLT on the basis that SLT was a “foreign affiliate” (i.e., Steinberg-related entities held more than 10% of the shares) but not a “controlled foreign affiliate”. Those forms were not produced, but they would disclose the name and address of SLT and certain financial information with respect to SLT, and would include the financial statements of SLT.

[157]    On June 19, 2008, Richter sent a fax on an anonymous basis under the Voluntary Disclosures Program with respect to the filing of Form T1134A by four taxpayers for the years 2001 to 2007.[112] Anne Bertrand, the official in charge of the Voluntary Disclosure Program within the Montreal TSO, informed Richter that the request could not be processed without the names of the taxpayers. On September 16, 2008, Richter filed Form T1134A on behalf of 2862565 for 2002 and for 4077211 and 2534-2825 for 2002 to 2006.[113]

[158]    3488055, 3488063 and 3488071 all held less than 1% of the equity of SLT, and therefore SLT is not a foreign affiliate or controlled foreign affiliate of those entities. The shares of SLT are foreign property, and 3488055, 3488063 and 3488071 are therefore required to file only Form T1135, which they did.

[159]    2534-2825 (from 1999 to 2010), 2862565 (from 1999 to 2002), 4077211 (from 2002 to 2008) and 3421848 (from 2007 to 2010) each held more than 1% of the equity and together held more than 10% in those years. As a result, SLT was a foreign affiliate (and potentially a controlled foreign affiliate) of those taxpayers for those years.

[160]    The explanation for the failure to file Form T1134A prior to 2008 is that Ludmer had two accountants filing the tax returns for different companies, and that neither accountant had enough information to conclude that the Ludmer companies together held 10% of the equity of SLT.[114]

[161]    On December 17, 2008, the voluntary disclosure group within the Montreal TSO wrote to the taxpayers advising them that it refused to accept the filings under the Voluntary Disclosures Program on the basis that the disclosure was not “voluntary” since “it was initiated following an audit.”[115] Instead, the filings were forwarded to the Montreal TSO audit team for assessment and penalties.[116]

[162]     This raises the first issue: did the voluntary disclosure group act reasonably in refusing the voluntary disclosure because it was not “voluntary” since “it was initiated following an audit”?

[163]    Ludmer was not formally advised that he was under audit until January 9, 2009,[117] more than six months after the initial contact by Richter.

[164]    However, the Montreal TSO had been working on SLT-related matters for some time prior to that. SLT had first come to the attention of the Montreal TSO in 2005 in the context of the RPI. By June 2008, the Montreal TSO had gathered information about SLT from a variety of sources, including a number of taxpayers, the internet, securities commissions, BNS and TD. The CRA had issued requirements to produce to BNS and TD.

[165]    The voluntary disclosures group met with the audit team on October 9, 2008. The audit team presented various documents showing that Ludmer was in contact with BNS and TD on a variety of issues related to SLT and that the banks seemed to regard him as the representative of the SLT shareholders and a key representative of SLT. Some of the documents dated as far back as 2001, but there was an email dated January 21, 2008. Of particular interest was an internal TD email dated November 6, 2007 which suggests that TD discussed the CRA requirements to produce with Nat Boidman of Davies, who was acting for GAM but who also seemed to take instructions from Ludmer.[118]

[166]    The audit team also showed the voluntary disclosures group the various requirements to produce sent to BNS and TD in 2007 and 2008 in relation to SLT, with the most recent orders being issued three days before the voluntary disclosure process was initiated by Richter.

[167]    These steps constitute enforcement action initiated by the CRA on a person associated with Ludmer that was sufficiently related to the disclosure and was likely to uncover the information being disclosed. This would have been sufficient for the voluntary disclosures group to refuse the disclosure as not being voluntary.

[168]    The voluntary disclosures group went one step further and concluded that Ludmer must have known about the audit of SLT and the information requests addressed to BNS and TD.[119]

[169]    Ludmer’s attorneys met with representatives of the voluntary disclosure group and the audit team on January 16, 2009. Oslers described the meeting as follows:

It is our understanding, based on your comments at the January 16, 2009 meeting, that the CRA’s refusal to accept the Taxpayers’ applications is premised on the assumption that, at the time of the Taxpayers’ voluntary disclosure applications, the Taxpayers knew or were aware of correspondence between unnamed third parties (the “third-party correspondence”) concerning a Court order that had been issued against one of the third parties requesting a list of shareholders of Saint Lawrence trading Inc. (“SLT”).[120]

[170]    Oslers indicated on February 4, 2009 that Ludmer wished to appeal administratively from the refusal to accept his voluntary disclosure, but that he needed to review the third party correspondence in order to do so.[121]

[171]    No appeal was produced in the Court record, so it is reasonable to conclude that Ludmer decided not to file an appeal. In any event, this issue was overtaken by subsequent events in the file when the Montreal TSO concluded a few months later that SLT was not just a foreign affiliate necessitating Form T1134A, but rather was a controlled foreign affiliate necessitating Form T1134B. At that point, the audit team took the position that the voluntary disclosure “no longer had any basis in law”.[122]

[172]    In any event, to the extent that it is necessary to come to a conclusion on this issue, the Court concludes that the CRA acted reasonably in that it had sufficient evidence to raise a serious doubt as to whether Ludmer knew of the existence of the audit prior to June 2008. In addition to the steps taken with the banks, other SLT shareholders were being audited by June 2008. The likelihood of communications among the shareholders was very real. One document that the CRA received later in the process was a memo from Robert Raich of Spiegel Sohmer dated July 17, 2007 in which he described a conversation between his partner David Sohmer and Ludmer in relation to SLT:

Also note that David Sohmer spoke to Irving Ludmer who told him Sam Minzberg’s client who is also being re-assessed will also elect to be governed by the new rules.[123]

[173]    Meanwhile, by July 8, 2009, the Montreal TSO had concluded that SLT was a controlled foreign affiliate of 2534-2825, 4077211 and 3421848 for some or all of the years between 2004 and 2007 and it asked those taxpayers to file Form T1134B.[124]

[174]    The audit team met with Oslers on July 14, 2009 and advised that its determination that SLT was a controlled foreign affiliate of 4077211, 2534-2825 and 3421848 was based on third party information that it could not disclose to Oslers.[125]

[175]    Oslers filed Form T1134B on behalf of the three taxpayers for taxation years 2004 to 2007 on August 5, 2009 under reserve of its right to contest the determination.[126] Oslers filed Form T1134B for taxation year 2008 on November 5, 2009 under the same reserve.[127]

[176]    Ultimately, the conclusion that SLT was a controlled foreign affiliate of 2534-2825 and 4077211 for the years from 2003 to 2009 and 3421848 for the years from 2006 to 2009 is not contested.

[177]    However, the issue and the debate on this issue had three consequences:

1.    As mentioned above, the audit team took the position that because Form 1134B was required and the voluntary disclosure related to Form T1134A, the voluntary disclosure no longer had any basis in law;[128]

2.    The Montreal TSO raised the possible application of penalties for the failure to file Form T1134B;[129] and

3.    Ludmer started the ATIA process on August 19, 2009.[130] One of his purposes was to respond to the Montreal TSO’s conclusion that SLT was a controlled foreign affiliate of 3421848, 2534-2825 and 4077211.[131]

[178]    The issue of the ATIA requests will be discussed in a separate section of this judgment.

[179]    As for the penalties, the Montreal TSO first mentioned the possibility of penalties under Sections 162(7), (10) and (10.1) ITA In its letter dated July 8, 2009.[132]

[180]    The maximum penalties under Sections 162(7) and 162(10) ITA are relatively small:

·        Section 162(7) ITA provides for a penalty of $25 per day for a maximum of 100 days (in other words a maximum of $2,500) for the late filling of an information return, and

·        Section 162(10) ITA provides for a penalty of $500 per month up to a maximum of 24 months (in other words a maximum of $12,000) for the late filing of an information return relating to foreign property.

[181]    However, if the taxpayer “knowingly or under circumstances amounting to gross negligence” failed to file an information return relating to foreign property for more than 24 months, Section 162(10.1) ITA provides that the fine is 5% of the cost of the foreign property.

[182]    When the Plaintiffs challenged the application of Section 162(10.1) ITA, the Montreal TSO invoked instead the penalty under Section 163(2.4) ITA for “knowingly or under circumstances amounting to gross negligence” making a false statement. That penalty is equal to the greater of $24,000 and 5% of the cost of the foreign property.[133]

[183]    The Montreal TSO letter of July 8, 2009 referred to the due diligence exception under Section 233.5 ITA for information that was not available, and the Minister’s discretion to cancel penalties under Section 220(3.1) ITA.

[184]    In its response on August 5, 2009, Oslers filed the Form T1134B returns under reserve and asked the CRA to waive or cancel the penalties under Section 220(3.1) ITA on the basis that Ludmer did not know or could not be reasonably be expected to know of the relevant Canadian shareholders and related persons.[134]

[185]    Meanwhile, the Montreal TSO sought to obtain further information from Ludmer in support of its claim that Ludmer must have known about the SLT audit and that SLT was a controlled foreign affiliate of 3421848, 2534-2825 and 4077211.[135] Ludmer made a motion to quash the requirement to produce documents under Section 8 of the Charter of Rights and Freedoms.[136]

[186]    On October 1, 2009, the audit team provided Oslers with a summary of the information on which it relied with respect to Ludmer’s knowledge. Essentially, the information related to communications between Davies (which was then acting for SLT and to some extent Ludmer), Ludmer and the banks in 2001 and 2004 in which the banks refer to Ludmer as acting on behalf of the shareholders of SLT. Some of those memos refer to “six prominent Canadian business families” owning approximately 80% of the equity of SLT.[137]

[187]    The Montreal TSO also continued its efforts to obtain further information from the taxation authorities in Ireland, the Netherlands and Bermuda.[138] The Montreal TSO finally received the list of SLT shareholders from the Irish authorities in 2010.[139]

[188]    The audit team ultimately calculated the penalties to which Ludmer was liable at $16.8 million, including the “gross negligence” penalties.[140]

[189]    Communications continued between the audit team and Oslers with respect to the penalties in 2010 and early 2011.[141] Oslers continued to insist that Ludmer did not have enough information to determine that SLT was a controlled foreign affiliate and complained that the CRA was not providing any information. The CRA sent a detailed letter on June 14, 2010.[142] Finally, on April 29, 2011, Oslers sent five binders of documents explaining Ludmer’s involvement in SLT.[143]

[190]    The CRA finally abandoned its position on the penalties on December 11, 2013.[144] The possibility of penalties had never gone beyond a possibility, and no steps were ever taken by the auditors to have penalties approved in order to form part of a reassessment.

[191]    Ludmer argues that the CRA committed a fault in threatening to impose these penalties:

·        The principal argument is that Ludmer could not have known that SLT was a controlled foreign affiliate because he did not have detailed information about the other shareholders;

·        Ludmer also advances technical arguments:

o   The filing penalty under Section 162(10.1) ITA required a filing delay of 39 months from the year end and the forms were filed within 20 months of the amendment requiring them;

o   The penalty under Section 163(2.4) ITA did not apply because there was no false declaration;

·        Finally, Ludmer also suggested that the Montreal TSO had a financial motive for imposing these penalties and that the penalties were part of a personal vendetta against Ludmer.

[192]    The Court rejects the principal argument.

[193]    Ludmer was involved in SLT and its predecessors from 1987 and he played a leading role. As such, it is reasonable to think that he knew the identities of the other shareholders. Ludmer received shareholder lists over the years, including through Sandringham which was entitled to a fee on the holdings of certain shareholders. Moreover, there were documents available to Ludmer referring to the fact that “six prominent Canadian business families” owned approximately 80% of the equity of SLT, which necessarily meant that five families controlled 50%. Further, in a letter dated July 12, 2001 discussing the reorganization of GAM Diversity, Davies stated that the reorganization would result in GAM Diversity becoming a controlled foreign affiliate of at least one or more of the Canadian shareholders.[145] Ludmer testified that he had seen this letter, but he did not believe that he was the family for whom SLT would become a controlled foreign affiliate.

[194]    All of this may not be sufficient to prove that SLT is a controlled foreign affiliate of the Ludmer SLT Plaintiffs, because there must be groups of related parties as defined in the ITA, but there is a sufficient basis to suspect that the test is met. The Court cannot assess whether the CRA would have been able to meet its burden of proof on Ludmer’s knowledge. However, the Court can and does conclude that the CRA did not act unreasonably in taking the position that Ludmer knew that SLT was a controlled foreign affiliate for certain of his companies.

[195]    The technical arguments appear to be well founded, but only with respect to Section 162(10.1) ITA and Form T1134B. SLT was not a controlled foreign affiliate of 3421848, 2534-2825 and 4077211 prior to the amendment of the definition of controlled foreign affiliate in December 2007, such that there was no obligation to file Form T1134B prior to that amendment. The amendment was retroactive to 2003, and therefore 3421848, 2534-2825 and 4077211 were required to file Form T1134B for the years 2004 to 2007, but only as of December 2007. As a result, when 3421848, 2534-2825 and 4077211 filed those forms in August 2009, they were only 20 months late. The 5% penalty is only payable if the filing is 39 months late.

[196]    However, the technical arguments fail with respect to Form 1134A. The obligation to file Form T1134A existed before the December 2007 amendments and is not affected by those amendments, and some were filed more than 39 months after the relevant year end.

[197]    Ludmer also argues that filing Form T1135 instead of Form T1134B cannot be a false declaration triggering the application of Section 163(2.4) ITA. The Court does not agree. Filing a form necessarily involves the representations that the requirements for filing that form are met and that it is the appropriate form in the circumstances. In the email referred to by the Plaintiffs in their written argument, Charette says that Section 163(2.4) ITA cannot apply if no form is filed, presumably because there is no statement made. He does not say that it cannot apply if the wrong form is filed.[146]

[198]    Finally, Ludmer relies on the correspondence discussing the issue of whether the Montreal TSO will receive appropriate credit for the penalties in the form of “TEBA” or “widgets”[147] as support for the suggestion that the Montreal TSO had a financial motive for imposing the penalties. The Court does not accept this suggestion. The TEBA or widgets did not provide much incentive for imposing penalties. Moreover, there was a reasonable basis for imposing penalties on Ludmer.

[199]    It is also worth noting that the Montreal TSO took a similar position with other taxpayers who held shares in SLT,[148] which suggests that it was not a personal vendetta against Ludmer.

[200]    The Court dismisses this ground of fault.

2.    Failing to move the matter forward expeditiously

[201]    The Montreal TSO formally advised Ludmer that he was under audit on January 9, 2009.[149] Steinberg appears to have been advised that he was under audit at about the same time.

[202]    The audits were completed more than three years later when the Montreal TSO issued final reassessments with respect to the remaining Plaintiffs for the remaining years between 2005 and 2010 in May 2012,[150] or when it issued its Auditor’s Report on June 27, 2012.[151]

[203]    Moreover, the audit of SLT had commenced in 2006.[152]

[204]    The ITA requires the Minister to examine the taxpayer’s tax return “with all due dispatch”, assess the tax, interest and penalties payable, and issue a notice of assessment to the taxpayer.[153]

[205]    The Minister then has three years to conduct an audit and reassess the taxpayer.[154]

[206]    In this matter, the Plaintiffs complain that the CRA failed to move the matter forward expeditiously. The time that the audit has been ongoing and the CRA’s delays in responding to matters are recurring themes in the correspondence from the Plaintiffs.[155]

[207]    One specific complaint made by the Plaintiffs in this regard is the failure of the CRA to agree to submit a question with respect to the possible application of Regulation 7000 to the Tax Court pursuant to Section 173 ITA:

173 (1) Where the Minister and a taxpayer agree in writing that a question of law, fact or mixed law and fact arising under this Act, in respect of any assessment, proposed assessment, determination or proposed determination, should be determined by the Tax Court of Canada, that question shall be determined by that Court.

[208]    The request for a Section 173 ITA determination can only be made if both the CRA and the taxpayer agree in writing.

[209]    The question of a Section 173 ITA determination was raised by Oslers as early as March 16, 2010, when Oslers, frustrated with the progress in the file, sent an email to Me Ian Demers of the Department of Justice with a number of concerns.^[156] One of the issues raised was the possibility of a Section 173 ITA determination with respect to the possible application of Regulation 7000.

[210]    The response came from Armanious on March 18, 2010.^[157] He indicated that he was waiting for Rulings with respect to Regulation 7000 and GAAR and that he would be in a better position to comment on Section 173 ITA once he received the answer from Rulings.

[211]    Oslers requested the CRA’s position within 30 days and pressed Armanious to move forward with the Section 173 ITA reference:

You advise in your letter that a decision as to the usefulness of a s.173 reference with respect to the application of regulation 7000 should be deferred until Rulings has opined and until Justice has been consulted. We do not quarrel with your need to consult further, but do ask that you commence discussions now in this regard to determine whether or not a s.173 reference is a process that you would entertain. To our minds, it is well worth a discussion given that it would allow both parties to move forward expeditiously and cost-effectively. We note as well that you have raised the concern of “secondary positions” to the use of the s.173 reference. We do not believe that such positions should inhibit its use, but to the contrary this reference mechanism may be an effective determinant as to these positions.^[158]

[212]    On April 15, 2010, Armanious wrote to explain that the file was too complex to provide the answers requested within 30 days.^[159]

[213]    The Montreal TSO received the Fifth TI from Rulings on June 29, 2010.^[160]

[214]    Oslers continued to push to get answers to its submissions on Section 94.1 ITA and Regulation 7000, and the possibility of a Section 173 ITA reference on these issues.

[215]    It is not clear whether the CRA ever seriously considered a Section 173 ITA reference and rejected it, or whether the question was never seriously considered. Either way, no Section 173 ITA reference was ever made.

[216]    It is possible that a Section 173 ITA reference might have saved the parties time and money. However, that is not necessarily true.

[217]    In the case of another SLT shareholder, Barejo Holdings ULC, the parties made a joint reference to the Tax Court under Rule 58 of the Tax Court Rules for the determination of whether the Notes constitute debt for the purposes of the ITA. Rule 58 is a procedure similar to Section 173 ITA and will be discussed below. The Tax Court concluded that the Notes are debt for the purposes of the ITA.[161] However, what is more relevant at this stage of the analysis is that the Federal Court of Appeal dismissed the appeal on the basis that answering the question did not resolve anything in the context of the underlying tax appeal, and therefore disposing of the appeal on the merits would serve no useful purpose and would give rise to an improper use of judicial resources.

[218]    Similarly, the Ludmer SLT Plaintiffs proposed questions under Rule 58 with respect to Section 94.1 ITA in the context of their appeals to the Tax Court, which were refused by the Justice Woods as inappropriate.[162] Her decision was upheld on appeal.

[219]    While it can be argued that the outcome of both cases would have been different with a properly formulated question, they nevertheless illustrate the limitations on Section 173 ITA.

[220]    Further, the possible use of Rule 58 is interesting. Rule 58 provides in part as follows:

58 (1) On application by a party, the Court may grant an order that a question of law, fact or mixed law and fact raised in a pleading or a question as to the admissibility of any evidence be determined before the hearing.

(2) On the application, the Court may grant an order if it appears that the determination of the question before the hearing may dispose of all or part of the proceeding or result in a substantially shorter hearing or a substantial saving of costs.

…

[221]    This procedure is analogous to Section 173 ITA, with two important distinctions. First, Rule 58 is available only in the context of a pending tax appeal whereas Section 173 ITA, on the other hand, is available in the context of “any assessment, proposed assessment, determination or proposed determination”. Probably for that reason, the second distinction is that the Section 173 ITA reference is available only when both parties consent, whereas the Rule 58 determination can be sought by either party.

[222]    This means that if the Plaintiffs really wanted the Regulation 7000 issue to be determined expeditiously by the Tax Court, they could have appealed the reassessments that they had received in 2009 and 2010 and put a question to the Tax Court under Rule 58, or they could have taken other steps to ensure that the appeals moved forward.

[223]    It would have been preferable if the CRA had considered whether a Section 173 reference should be made, had come to a reasonable conclusion on the question, and had informed the Plaintiffs. The evidence does not allow the Court to conclude that this was done. However, it is not clear that the CRA had a legal obligation to consider Section 173 ITA. The Court is not prepared to conclude that the failure to consider making a Section 173 ITA reference is a fault.

[224]    The Plaintiffs argue that the CRA’s failure to agree to a Section 173 ITA reference is further evidence “that the CRA was determined to exhaust the Plaintiffs in order to simply extract a payment.”[163] There is no direct evidence to support that argument.

[225]    Moreover, it is not clear that the failure to consider making a Section 173 ITA reference had any consequences. There is no evidence that a clear question could have been put to the Tax Court that would have saved time and money. If the Plaintiffs believed that they could have put such a question to the Tax Court, they could have proceeded unilaterally under Rule 58.

[226]    The Court dismisses this ground of fault.

3.    Unreasonable assessing positions and final reassessments

3.1   Introduction

[227]    Before reviewing the reasonableness of the CRA’s final assessing positions, it is important to emphasize that the CRA abandoned those positions in 2014, by giving the SLT Plaintiffs the benefit of the CIF rules for all taxation years ending before March 5, 2010 and by finding that under the CIF rules there was no income to be imputed to the SLT Plaintiffs in relation to SLT.

[228]    While it is undoubtedly true that the CRA was outgunned by Oslers and Davies and the other counsel representing the SLT shareholders, the CRA cannot abandon a position that it believes to be well-founded because it is difficult.[164]

[229]    As a result, the abandonment of the position creates a presumption that the position was wrong.

[230]    This does not mean that the CRA is liable. The CRA is entitled to take a wrong position. It will not be liable if it acts reasonably in taking that position and if it does not cling unreasonably to the position after it should know that it is wrong.

3.2   Assessing positions

[231]    The Montreal TSO issued protective reassessments to certain SLT Plaintiffs for certain years in 2009 and 2010, and issued the final reassessments for the remaining SLT Plaintiffs and for the remaining years in May 2012. The final assessing positions taken by the Montreal TSO in support of the reassessments are set out in detail in the Auditor’s Report dated June 27, 2012.[165]

[232]    The reassessments were issued under the current OIF rules. The CRA presented four assessing positions in the Auditor’s Report, namely a primary and a secondary position for the non-CFA taxpayers and a primary and a secondary position for the CFA taxpayers:

Non CFA:

Current OIF Rules	Former FIE Rules	Portfolio Investments	Income if held personally
Position 1 - Current 94.1	Subsection 94.1(3) by virtue of section 94.3 (i.e. Accrual Method)	Notes	Regulation 7000
Position 2 - Current 94.1	N/A	Reference Assets	Income from Reference Assets

 CFA:

FAPI	Former FIE Rules	Portfolio Investments	Imputation to Cdn shareholders
Position 3 - Description A	N/A	N/A	Regulation 7000
Position 4 - Description C	Paragraph 95(2)(g.3)	Reference Assets (i.e., Notes)	94.1

[233]    For the non-CFA taxpayers, Section 94.1 ITA requires the following elements:

·        The taxpayer holds shares in a non-resident entity (i.e. SLT);

·        The shares in SLT derive their value directly or indirectly from “portfolio investments” (i.e. from the Notes (directly) or from the Reference Assets (indirectly)); and

·        One of the main reasons for the taxpayer acquiring or holding the shares in SLT was to pay significantly less tax than if the portfolio investments were held directly by the taxpayer:

o   This requires an analysis of the taxpayer’s motive for investing in SLT;

o   It also requires an analysis of whether the taxpayer would have been required to pay tax if he held the Notes or Reference Assets directly rather than through SLT. For the Notes, the Montreal TSO took the position that the increase in value of the Notes was deemed to be interest income under Regulation 7000 that would have been taxable if the taxpayer held the Notes. For the Reference Assets, the taxpayer would have included the gains on disposition, interest and dividends.

[234]    If the test in Section 94.1 ITA is met, the taxpayer must include in his income the difference between a prescribed return on the cost of the SLT shares and the actual income derived from those shares. The prescribed rate of return during the period 2002 to 2005 ranged from 2 to 4%, and the actual income was nil.

[235]    The CFA taxpayers must include in their income their proportional share of SLT’s FAPI:

·        Under element A of the definition of FAPI, SLT’s FAPI includes its income from property. The Montreal TSO took the position that the increase in value of the Notes was deemed to be interest income of SLT under Regulation 7000;

·        Under element C of the definition of FAPI, SLT’s FAPI includes its income if Section 94.1 ITA applied at the level of SLT with certain modifications. This involves the same analysis as above: SLT holds the Notes, which are the offshore investment fund property; the Notes derive their value directly from the Reference Assets; and the gains on disposition, interest and dividends from the Reference Assets would be taxable if held directly. As a result, the gains and losses on the Reference Assets are treated as SLT’s FAPI and are allocated to the shareholders.

[236]    The proposed FIE rules were intended to replace the current OIF rules. The reassessments by the Montreal TSO were based on the current OIF rules. By the time the Montreal TSO completed its analysis, the proposed FIE rules had been abandoned and the CIF rules were only in draft form.

[237]    The Montreal TSO added its analysis of the CRA’s assessing options if the CIF rules came into force as they were then drafted (which is effectively what happened a year later):

Non CFA:

Current OIF Rules	Former FIE Rules	Portfolio Investments	Income if held personnally	Impact of the August 27, 2010 CIF on Reassessments
Position 1 - Current 94.1	Subsection 94.1(3) by virtue of section 94.3 (i.e. Accrual Method - being the Regulation 7000 income)	Notes	Regulation 7000	R Accrual Method will impute the income held by SLT (being the Regulation 7000 income vis-à-vis the Notes)
Position 2 - Current 94.1	N/A	Reference Assets	Income from Reference Assets	Q Non applicable as the former FIE rules do not permit one to consider the income earned of "any" non-resident entity as is the case with current section 94.1

CFA :

FAPI	Former FIE Rules	Portfolio Investments	Imputation to Cdn Shareholders	Impact of the August 27, 2010 CIF on Reassessments
Position 3 - Description A	N/A	N/A	Regulation 7000	R CIF does not have any bearing on Regulation 7000
Position 4 - Description C	Paragraph 95(2)(g.3)	Reference Assets	94.1	R CIF does not technically apply as the taxpayers are not subject to an inclusion or deduction under the Draft FIE regime - see ITRD # 2010-039121. Furthermore, as discussed in this report, after consultation with the Department of Finance, the cash-settled derivative exception does not apply to SLT.

 

[238]    For the non-CFA taxpayers, the proposed FIE rules would replace the current OIF rules in Section 94.1 ITA. The proposed FIE rules apply when the taxpayer owns a “participating interest” in a “foreign investment entity”. The Montreal TSO took the position that the shares of SLT were “participating interests” in a “foreign investment entity”.

[239]    If the proposed FIE rules apply, the taxpayer must elect to include in his income for the year one of three amounts. The Montreal TSO based their assessing position on the assumption that the Plaintiffs would choose to include their share of SLT’s income, similar to the FAPI rules.

[240]    The calculation of SLT’s income therefore raised the same issues as under the current rules, and the Montreal TSO again took the position that the increase in value of the Notes was deemed to be interest income of SLT under Regulation 7000, which was not affected by the proposed FIE rules. The Montreal TSO recognized that its secondary position under the current rules, that it could consider the gains on disposition, interest and dividends on the Reference Assets, did not work under the proposed FIE rules, because the proposed FIE rules include only the income earned on the portfolio investments of the FIE and not the income earned indirectly on the portfolio investments of another non-resident entity.

[241]    For the CFA taxpayers, the proposed FIE rules provide that an interest in a controlled foreign affiliate is an “exempt interest”. As a result, the proposed FIE rules do not apply and the interest continues to be taxed under the FAPI rules, as modified. The Montreal TSO took the position that the increase in value of the Notes was deemed to be interest income of SLT under Regulation 7000 and element A of the definition of FAPI. The Montreal TSO took the position that SLT’s FAPI under element C includes its income under the proposed FIE rules: the Notes are a participating interest in the issuers, which are the foreign investment entities, and SLT’s FAPI is the gains on disposition, interest and dividends from the Reference Assets.

[242]    Further, the CRA took the position that the CIF rules technically did not apply to the Plaintiffs because (1) the Plaintiffs did not include an amount of income under the proposed FIE rules, and (2) the Plaintiffs did not voluntarily comply with the proposed FIE rules.^[166]

[243]    The CRA abandoned these positions in 2014:

·        The CRA gave the Plaintiffs the benefit of the CIF rules for all taxation years ending before March 5, 2010;

·        Under the CIF rules, the Plaintiffs were entitled to apply the proposed FIE rules; and

·        Under the proposed FIE rules, the CRA recognized that the Plaintiffs had no income from SLT.

[244]    To find that the Plaintiffs had no income from SLT under the proposed FIE rules, the CRA must have concluded that Regulation 7000 did not apply.

[245]    The Plaintiffs’ criticisms of the assessing positions and final reassessments can be summarized as follows:

1.    The CRA applied the current OIF rules, which were the wrong rules for taxing non-Canadian investments at that time;

2.    The CRA did not even apply the current OIF rules correctly:

                              i. The SLT Notes do not qualify as “portfolio investments”

                             ii. The Plaintiffs did not have a tax-reduction motive

                           iii. The CRA misapplied Regulation 7000 to deem income where there was none

3.    The CRA did not apply the proposed FIE rules correctly or give the Plaintiffs the benefit of the CIF rules when the proposed FIE rules were abandoned;

4.    The reassessments had no reasonable prospect of success and took the strongest assessing positions in order to get maximum leverage for settlement.

3.3   Development of the CRA’s position

[246]    Before reviewing the reasonableness of the CRA’s position, it is useful to review how it was arrived at.

3.3.1    Position prior to SLT

[247]    Equity-linked notes or ELN are debt obligations, usually issued by a financial institution, where the return is linked in some way to the performance of the reference assets, which can be a single stock, a basket of stocks or an equity index, over the term of the obligation. They are a subset of linked notes, which also include notes where the return is linked to something other than equity, such as a commodity or a currency.

[248]    Principal-protected notes or PPN are a form of equity-linked note in which the holder is guaranteed to receive the original amount invested plus the potential of a return linked to the performance of the reference assets. Under a non-principal-protected note, the investor may not receive the original amount invested.

[249]    The Notes are a form of equity-linked note. They are not principal-protected notes since SLT will receive less than the original amount invested if the value of the Reference Assets is lower at maturity.

[250]    Rulings and Finance had considered the taxation of equity-linked notes and principal-protected notes prior to dealing with SLT.

[251]    Starting in 1992, the CRA issued a number of rulings and technical interpretations respecting the application of Regulation 7000(1)(d) and 70000(2)(d) to equity-linked notes.[167]

[252]    The various equity-linked notes considered by the CRA had features similar to the Notes:

·        Five-year debt obligation with 3% annual interest plus a bonus at maturity based on the performance of the TSE 35 Index;[168]

·        Two-year debt obligation with no annual interest and a bonus payable on maturity based solely on the TSE 100 Stock Index;[169]

·        Five-year term deposit with 2.25% annual interest payable at maturity and a bonus payment payable at maturity based on the performance of the TSE 35 Index;[170]

·        Five-year notes with no annual interest and a bonus payable on maturity calculated with reference to the Standard & Poor’s 500 index;[171] and

·        Three-year term deposit with no annual interest and a bonus payable at maturity calculated by reference to an increase in the value of a particular stock or stock index.[172]

[253]    In some cases, there was a secondary market for these equity-linked notes.^[173]

[254]    The CRA, after consulting with Finance, took the following position:

Based on the foregoing, it is our view that the stock-index linked return on a GIC investment is a bonus or premium payable in respect of the obligation, as it is an amount over and above the amount of interest stipulated to be payable under the contract. The amount of the stock-index linked return is therefore deemed to be interest payable under the GIC for the purposes of section 7000 of the Regulations, by virtue of subsection 7000(3) of the Regulations. Because the amount of the deemed interest depends on a contingency that exists after the end of each year in which the GIC is held (i.e. the stock-index level at maturity), it is our view that a stock-index linked GIC is a prescribed debt obligation described in paragraph 7000(1)(d) of the Regulations.

As a prescribed debt obligation described in paragraph 7000(1)(d) of the Regulations, for each year that the taxpayer holds the stock index linked GIC, the taxpayer must include in computing income pursuant to subsection 12(4) of the Act, the amount of interest that is deemed to accrue by virtue of subsection 12(9) of the Act and paragraph 7000(2)(d) of the Regulations. In this regard, where the amount of the stock-index linked return is based solely on the level of the relevant stock-index at the maturity date, for each taxation year that a taxpayer holds a stock-index linked GIC on an anniversary day of the GIC prior to the year of maturity the maximum amount of interest that could be payable in the year with regard to the deeming provision in subsection 7000(3) of the Regulations is unknown and therefore no amount is required to be accrued into income in each of these years. In the year the contract matures and the amount of the stock-index linked return is known, it is our view that, the full amount of the stock-index linked return is the maximum amount of interest that could be payable under the GIC in the year of maturity for the purposes of paragraph 7000(2)(d). Therefore, in the year of maturity of the contract, the full amount of the stock-index linked return on the GIC is deemed to be interest accrued on the obligation and must be included in the taxpayer’s income for the year in which the contract matures pursuant to subsection 12(4) of the Act.[174]

(Emphasis added)

[255]    As a variation on this analysis, where the taxpayer has the right to “lock-in” the amount of the bonus prior to maturity and exercises that right, such that the amount payable at maturity is known in advance, then the taxpayer is required to accrue a portion of that amount in the year in which the amount was locked-in and the remainder in the remaining years of the term.[175]

[256]    However, the CRA had expressed its concern to Finance in the 1990s that this was not the appropriate outcome in these instances:

In our view, the accrual rules, designed to prevent interest income deferrals, can be neutralized by the use of a small contingency so that there is no known maximum amount.

We would appreciate the view of Finance, as financial institutions are getting more creative in their marketing of these types of products.[176]

[257]    The CRA suggested to Current Amendments at Finance that Regulation 7000(2)(d) be amended such that, if the maximum rate cannot be determined, the taxpayer be required to include in income each year an amount calculated at a prescribed rate.[177]

[258]    Finance indicated in 1993-94 that its policy on taxation of these contingent bonus payments was clear, “interest should be brought into income on a rational basis throughout the term of the obligation”, but it “recognized the weaknesses of the current accrual rules in achieving this policy result”. Finance was reluctant to introduce “band-aid amendments” but rather their objective was “to replace the current patchwork of rules - some of which were developed in response to specific problems - by a comprehensive regime that is founded on basic principles”. Finance asked to be kept informed as to any developments in this area.[178]

[259]    As a result, in the 1990s and 2000s, equity-linked notes were not taxed on an annual basis but only (1) on maturity, (2) when the return was locked-in, or (3) when the note was sold.

[260]    The financial sector acted in accordance with that position. Various prospectuses issued by Canadian financial institutions for equity-linked notes were provided by the taxpayers or were analyzed by the CRA in the course of the SLT audits.[179] The Plaintiffs also produced a number of additional prospectuses at the trial.[180]

[261]    The prospectuses issued in 2006 through 2008 state that, based on the CRA’s administrative practice, there should be no deemed accrual of interest until maturity or until such time as the amount payable or a minimum amount payable becomes calculable.[181]

[262]    There was also the argument that if the equity-linked note was held as capital property and was sold prior to maturity, the gain on the sale would be a capital gain and not income.

[263]    As a result, the prevailing position when the SLT Notes came to the attention of the Montreal TSO was that equity-linked notes were an effective means to defer tax and to convert the income into a capital gain.

[264]    Moreover, it is fair to assume that when counsel devised the SLT structure and in particular created the Notes, their intention was to obtain the benefit of this interpretation of Regulation 7000 for the benefit of the shareholders of SLT.

[265]    It was not until 2016 that Finance began to develop the comprehensive regime for equity-linked notes that it first mentioned more than 20 years earlier. Budget 2016 deemed the gain realized on the sale of an equity-linked note to be interest income and not a capital gain.[182] However, the interest accrual rules were not amended, with the result that the deferral advantage appears to have been preserved. As stated by McCarthy Tétrault in its analysis of the 2016 budget:

The Budget Documents also state that investors generally take the position that there is no deemed accrual of interest on a linked note prior to the maximum amount of interest becoming determinable. Instead, the full amount of the return on the note is included in the investor’s income in the taxation year when it becomes determinable, which is generally at or shortly before maturity. Although not stated in the Budget Documents, the position taken by investors is derived from administrative positions of the CRA.

…

Significantly, no change to the interest accrual rules is proposed to require investors to include any part of the contingent return in income before the amount is determined so that the deferral advantage is preserved.[183]

3.3.2    Initial position and First TI

[266]    Phisel discovered the SLT investments in the context of the RPI audit in 2005. Leduc also came across SLT in the context of the RPI audit of another taxpayer.

[267]    Phisel and Leduc began working together. They set about gathering information on SLT from a variety of sources, including the taxpayers under audit, other CRA audit files, the Autorité des marches financiers, the Ontario and British Columbia Securities Commissions, BNS and TD. They put this information in a master file that could be referenced when they audited shareholders of SLT.

[268]    By 2006, they came to the conclusion that the SLT investments were subject to Section 94.1 ITA.^[184] When they later found a SLT shareholder for whom SLT was a FCA, they concluded that FAPI applied.^[185] They advised the taxpayers accordingly.

[269]    However, before issuing any formal reassessments, they consulted with the ATP Division in order to seek technical assistance on the application of Section 94.1 ITA to the SLT structure.^[186] The ATP Division was specialized in aggressive tax structures.

[270]    On March 22, 2007, Phisel and Leduc gave a presentation to the ATP Division in Ottawa on the foreign entities that they had discovered in the course of the RPI. The presentation focused on SLT but included other offshore investment vehicles.^[187]

[271]    The ATP Division had invited Thomson, an officer in the International Division of Rulings, to the meeting to discuss the proposed FIE rules.^[188]

[272]    At the meeting, the auditors indicated that they were proposing to apply Section 94.1 ITA to SLT investments as well as FAPI if SLT was a controlled foreign affiliate, and they asked Thomson for her views.

[273]    Meanwhile, the lawyers representing SLT taxpayers raised a number of arguments:

·        David Sohmer of Spiegel Sohmer proposed that his client give waivers and that the CRA reassess once the FIE rules come into force.^[189] That suggestion appears to have been rejected.

·        Sohmer also argued that the motive test was not met in that his client’s motive for investing in SLT was “diversification, performance and risk” and not the deferral of Canadian tax.^[190]

·        Samuel Minzberg of Davies on behalf of another taxpayer chose to argue the technical aspects of Section 94.1 ITA as opposed to the motive test.^[191] He argued that the Notes are an “investment” but not a “portfolio investment” because “portfolio” implies a multiplicity of assets and not one or two, they were acquired through bilateral negotiation and contract with the borrower and not on the open market, and there is no ready market for the Notes;

·        Minzberg also argued that there was no tax benefit to not holding the Notes directly, because there was no income on the Notes and no deemed income because the Notes did not constitute a “prescribed debt obligation” under Regulation 7000. Minzberg referred to Total Return Linked Notes issued by the National Bank and Principal Protected Notes issued by the Business Development Bank.

·        Another taxpayer had sold its shares and offered to pay capital gains, but the Montreal TSO declined that offer.^[192]

[274]    The Montreal TSO forwarded all of the information that it had gathered to date as well as the submissions that it received from the taxpayers and their counsel, to the ATP Division and to Rulings.^[193]

[275]    Thomson issued the First TI on July 18, 2007.[194] In it, she concluded that the current Section 94.1 ITA and the proposed FIE rules applied:

·        She concluded that the current Section 94.1 ITA applied because the SLT shares indirectly derived their value from the Reference Assets, which constituted “portfolio investments” held by the offshore affiliates of the banks. She also stated that it was reasonable to conclude that the motive test was met.

·        She also concluded that the proposed FIE rules applied because the shares in SLT were a “participating interest” in a non-resident entity whose property was “investment property”.

[276]    However, she added the following with respect to Regulation 7000:

In computing its income for the year as if it were resident in Canada, Subsections 12(3), 12(4) and 12(9) of the Act will require SLT to include the income deemed to accrue each year on a “prescribed debt obligation”, as that term is defined in subsection 7000(1) of the Income Tax Regulations. The Notes are likely to be prescribed debt obligations. However, since the return on the investment is not known until the maturity date, no amount can be deemed to accrue for purposes of subsection 12(9) of the Act (see document 2006-016887). Therefore, if the taxpayer elects under subsection 94.3(3), there will be no income in SLT until the Notes mature.

[277]    As is clear from the discussion above, this conclusion was based on the position taken by the CRA on other equity-linked notes.[195]

3.3.3    Second TI

[278]    There was some pushback from the auditors and the ATP Division on the last part of the Thomson letter, where she concluded that no amount could be deemed to accrue under Regulation 7000.^[196]

[279]    Charette raised the issue as to whether Regulation 7000(1)(a) or 7000(1)(d) applied. Thomson spoke to Tremblay, a colleague in Corporate Financing Section of Rulings. She had not consulted with the Corporate Financing before issuing the First TI, but she relied on a series of past interpretations^[197] which she understood had involved Corporate Financing. Tremblay confirmed that Regulation 7000(1)(d) applied if at some point the maturity amount is locked in.^[198] Thomson invited the auditors and the ATP Division to talk to Tremblay.

[280]    Charette immediately emailed Tremblay and set up a meeting with Tremblay and the auditors for August 1, 2007.^[199] Thomson was not invited to the meeting.

[281]    Subsequent to the meeting, on September 26, 2007, the auditors sent a detailed memorandum to Tremblay setting out the relevant facts and their understanding that Regulation 7000(1)(d) applied such that the yearly increase in net value was deemed interest.^[200] They included in the package all of the information that they had gathered to date, as well as the submissions from counsel. They asked Tremblay whether the Notes were “prescribed debt obligations” under Regulation 7000.

[282]    Tremblay issued the Second TI on January 15, 2008.^[201] He concluded that Regulation 7000(1)(d) applied to the Notes because:

·        The increase in value of the Notes is a “bonus or premium” and is considered to be an amount of interest payable under the obligation; and

·        That amount of interest is dependent on a contingency existing after the year, namely the value of the Reference Assets at maturity of the Notes.

[283]    He cited the policy expressed by Finance in 1994, “interest should be brought into income on a rational basis throughout the term of the obligation”, and Finance’s recognition of the weakness of the current accrual rules in achieving that policy result. He referred to a number of rulings where the conclusion was that equity-linked notes were not taxable on an accrual basis because the return could not be calculated in respect of the year before maturity.^[202] All of this is consistent with Thomson and with past practice of the CRA.

[284]    However, Tremblay distinguished the Notes, saying that they were “unlike any contingency accrual note we have ruled on in the past”. He focused in particular on the shareholders’ right on the last Monday of each month to put their shares to SIL at fair market value (the “outside put”), which is based on the value of the Notes which is in turn based on the value of the Reference Assets. He also emphasized SLT’s right to reduce the Notes to pay its operating expenses[203] or to increase the Notes as new investors subscribe shares, and the possibility of disposing of the Notes before maturity. As a result, even though the value of the Notes at maturity will not be known until maturity, the value of the Notes can readily be calculated every month and the shareholder is entitled to put his shares and receive that amount. He mentioned that Thomson did not have access to these details.

[285]    On that basis, Tremblay concluded that “the maximum amount of interest thereon that could be payable thereunder in respect of that year” was calculable because the value of the Notes was calculable 12 times per year. The 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.

[286]    Tremblay also emphasized that “the deferral of the interest accrual rules was a motivation for this structure”. He warned that accepting this structure may be precedent setting. Finally, he supported the application of GAAR because “this arrangement appears to be an attempt to avoid the interest accrual rules and the provisions of section 7000 of the Regulations”.

[287]    The ATP Division asked Thomson to split the First TI into two, one for the current Section 94.1 ITA the other for the proposed FIE rules. They also asked her to revisit her conclusion on Regulation 7000 in light of the Tremblay ruling.^[204]

[288]    Thomson issued the Third TI and the Fourth TI on May 28, 2008.^[205] With respect to Regulation 7000, she says only that the shareholders will be required to include an amount equal to the interest accrued under Section 12 ITA.

[289]    Meanwhile, the auditors were sending Tremblay examples of other equity-linked notes which promised deferral of taxes.^[206] Leduc prepared a table comparing different notes.[207]

[290]    Tremblay arranged a meeting with Finance on June 11, 2008 to discuss principal-protected notes. Leduc also attended the meeting. The focus with respect to the principal-protected notes was the existence of a secondary market. SLT was also discussed at the same meeting. According to the note prepared by Finance:

Claude [Tremblay] is advising DOF that since Rulings has now been made aware that the investor can dispose of the note before maturity via a secondary market, they will be issuing a ruling that is in direct contrast to the previous one - ie. The ruling will state that the notes are prescribed debt obligations as defined by Regulation 7000(1) and therefore a maximum amount will be determined in accordance with Regulation 7000(2)(d) for an accrued interest income amount.^[208]

[291]    The conclusion of the meeting was that Witteveen would write a briefing note and that CRA and Finance might meet again. Tremblay testified that he believed that Finance would support his position. Witteveen wrote him a few days after the meeting:

FSP [Financial Services Policy Division] is concerned because they do not want this to look like finance is closing down the PPN, which they think plays a valuable role. Therefore we would like to set up a new meeting with you and FSP to discuss how to proceed.[209]

[292]    Finance issued a memo on October 30, 2008 in which it agreed with the CRA’s position that a principal-protected note with a repurchase mechanism was subject to the interest accrual rules:

We consider the CRA’s interpretation of the interest accrual rules in this case to be reasonable because the investor can determine the amount of the gain accrued at any particular time. We therefore have no reason to question the CRA’s decision to tax this particular type of PPN on an accrual basis. We note that the interpretation that the CRA proposes to apply in this ruling may affect some existing debt obligations held by individual Canadian retail investors. We anticipate that both these investors and Canadian banks would react negatively to the ruling. The Canadian Bankers Association has proposed that the interpretation in this ruling be applied on a prospective basis; however it is generally not possible for the CRA to apply an interpretation of existing provisions in this manner.[210]

[293]    As a result, at the end of 2008, Rulings and Finance appeared to agree that the Notes were subject to the interest accrual rules. Finance seems to regard this interpretation as a departure from the current interpretation. The technical interpretations in SLT have not been made public at this stage,[211] but it appears that the Canadian Bankers Association has been advised of the position on principal-protected notes.

3.3.4    Regulation 7000 revisited - the Fifth TI and the Justice Opinion

[294]    One year later, in July 2009, the auditors forwarded to Tremblay submissions by Davies on Regulation 7000.^[212] The auditors met with Tremblay and his director Mark Symes on September 3, 2009.

[295]    Meanwhile, the Ludmer and Steinberg audits began in early 2009. The Montreal TSO sent a proposal letter to Ludmer on May 8, 2009 and to Steinberg on June 22, 2009. Both were based on Section 94.1 ITA for non-CFA taxpayers and FAPI for CFA taxpayers.[213]

[296]    Oslers filed its representations on behalf of Ludmer on September 21, 2009^[214] and on behalf of Steinberg on October 13, 2009.[215] Oslers raised many of the same arguments as counsel acting for the other SLT shareholders. Oslers argued that the shares of SLT do not derive their value from portfolio investments, and that the purpose test was not met because no tax would have been payable if the Notes had been held directly. In addition, Oslers argued that the reorganization of SLT in 2001 so that it would not run afoul of the proposed FIE rules cannot serve as evidence of a tax avoidance motive. They argued that the Notes were equity-linked notes which are contractual swap arrangements and not “prescribed debt obligations” and that they were not taxable under Regulation 7000. They cited a number of CRA documents for what they characterized as the CRA’s long-standing position that the prescribed debt obligation rules do not apply to equity-linked notes.

[297]    The auditors forwarded to Tremblay their analysis of Regulation 7000 as well as submissions they had received from Davies and Oslers and asked for his views on whether the presence of a put provider helped the Regulation 7000 analysis, and on the foreign exchange methodology.^[216]

[298]    At the same time as it was working to obtain confirmation of its Regulation 7000 position, the Montreal TSO was working on secondary positions that were not dependant on Regulation 7000:

·        The secondary position for non-CFA taxpayers is that the Reference Assets are the portfolio investments from which the SLT shares indirectly derive their value. The gains on disposition, interest and dividends on the Reference Assets would be taxable if held personally;

·        The secondary position for CFA taxpayers is that under element C of the definition of FAPI, SLT’s FAPI includes its income under Section 94.1 ITA. This involves the same analysis as above: the Notes are the offshore investment fund property, they derive their value directly from the Reference Assets and the gains on disposition, interest and dividends from the Reference Assets would be taxable if held directly.^[217]

[299]    The Montreal TSO provided further input to Rulings with respect to the put facility under the SLT note and the distinctions between the SLT note and other notes issued by the Canadian banks.^[218]

[300]    There was a lengthy review, which included input from Symes and several conversations and exchanges of views with the auditors and the ATP Division. Symes was concerned about the use in the Second TI of the put price on the SLT shares under the “outside put” and the secondary market to value the SLT Notes for the purposes of Regulation 7000. Symes was concerned because the “outside put” related to the SLT shares and not the Notes. It gave the shareholder the right to put shares to the put provider and to receive payment from the put provider, and the secondary market meant a sale of the shares to a third party and the receipt of payment from a third party. Neither represented “interest thereon” [i.e. on the Note], or an amount “payable thereunder” or “payable under a debt obligation”, to use the expressions in Regulations 7000(2)(d) and 7000(3).

[301]    Symes instead emphasized the “inside put” in the SLT structure, whereby SLT had the right to terminate the Notes on 367 days’ notice, such that SLT could terminate the Notes and receive payment from the issuers in any year except the first year.[219]

[302]    Tremblay issued the Fifth TI on June 29, 2010.^[220] The conclusions can be summarized as follows:

·        The Notes are debt obligations because the legal form of the arrangement is debt;

·        Regulation 7000(1)(d) applies to the Notes because there is no stipulated interest rate but rather a return which is contingent on the value of the Reference Assets;

·        That return is interest income under Regulation 7000(3);

·        The Notes can be terminated on 367 days’ notice, and therefore could be payable in respect of any year other than the first year;

·        The value of the SLT shares, the Notes and the Reference Assets are all based on the same computation, and the put provides an accurate basis of valuation; and

·        Rulings supported the use of GAAR as an alternative argument to Regulation 7000.

[303]    Tremblay dealt at length with the argument that the TSO’s position was at variance with the CRA’s long-standing position on equity-linked notes, which he summarized as follows:

Specifically, since 1992, we have issued a number of rulings and technical interpretations and taken the position that the amount ascertained and payable on maturity is not subject to reporting on the accrual basis during the term of the obligation but rather is included in the holder’s income in the year it is received pursuant to paragraph 12(1)(c) of the Act.

[304]    Tremblay distinguished the earlier cases on the basis that in those cases, unlike SLT, the return cannot be calculated until maturity and the holder cannot demand payment until maturity.

[305]    Tremblay also referred to the ongoing review by Rulings of the impact of the availability of a secondary market on the application of Regulation 7000. He said that Rulings had not completed its review, but added that it was not relevant because a sale of the note on a secondary market was not the same as a redemption of the note with the issuer.

[306]    The bottom line is that Tremblay abandoned the “outside put” theory in favour of the “inside put”. He nevertheless continued to use the “outside put” and its 12 valuation dates to calculate the income inclusion under Regulation 7000, because those were the dates on which the CRA had values for the Reference Assets.

[307]    In 2010, at about the same time, Rulings received a legal opinion from Justice that the bid price offered by an affiliated institution for the note is not a maximum for purposes of Regulation 7000(2)(d).[221] This seems to have put an end to the “outside put” theory.

[308]    Tremblay called Finance because he wanted to announce at the upcoming Canadian Tax Federation conference that a bid price by an affiliate of an issuer of the principal-protected notes is not caught by Regulation 7000 and that such notes are not subject to the interest accrual rules.[222] He never received an answer from Finance and he made no announcement.[223] In the absence of an announcement, banks issuing principal-protected notes in 2011 added to their prospectuses a mention that the CRA “is currently reviewing its administrative practice in relation to the relevance of a secondary market for prescribed debt obligations such as the Notes in determining whether there is a deemed accrual of interest on such debt obligations.”[224]

[309]    The Plaintiffs argue that the Justice opinion left the CRA with no choice but to abandon its Regulation 7000 argument completely.[225]

[310]    However, that was not Tremblay’s position. He advised Finance that he maintained the position that they are subject to the interest accrual rules because of the “inside put”.[226]

3.3.5    Later developments

[311]    On September 7, 2010, the ATP Division made a GAAR application with respect to the approximately 200 Canadian investors in SLT.^[227] This was an alternative position if the Regulation 7000 arguments were rejected. A first meeting of the GAAR committee took place on September 21, 2010.^[228] The committee agreed on a preliminary basis that GAAR could be applied as an alternate position to the Regulation 7000 argument.^[229] Oslers was then invited to make its GAAR submissions, which it did on February 3, 2011.^[230]

[312]    Oslers asked for a meeting to present its point of view on all of the issues raised by the Montreal TSO. A meeting was scheduled for November 25, 2010. In advance of that meeting, Oslers sent submissions on November 18, 2010.^[231] Armanious forwarded the submissions to Rulings, with the comments of the Montreal TSO.^[232] Armanious, Phisel and Leduc attended the meeting, with Gibson and Charette from the ATP Division and Oliviero. Oslers wanted representatives from Rulings and from Justice present, but the CRA declined. No agreement was reached.

[313]    In the course of the meeting, Oslers provided written representations to the Montreal TSO,^[233] as well as two draft notices of application.^[234] The first draft notice of application dealt with the proposed reassessments and sought an order prohibiting the CRA from (1) reassessing until the CIF rules are enacted, (2) taking the 2001 reorganization into account in the motive test, (3) issuing a reassessment inconsistent with the CRA’s published administrative practice regarding Regulation 7000 or its treatment of other taxpayers, and (4) imposing penalties in relation to the Form T1134B. The second draft notice of application dealt with access to information issues.

[314]    In response to the draft notices of application, Gibson undertook that the Plaintiffs would be given five days’ notice before any proposed reassessment to allow the Plaintiffs to present their applications, if they wanted to do so.

[315]    On December 3, 2010, the Montreal TSO responded to a number of issues.^[235] The Montreal TSO requested that Oslers provide a submission for a principled resolution to the SLT matters.

[316]    Oslers filed further representations on the CIF issue on December 14, 2010 and on the foreign exchange and reserve for doubtful accounts issues on December 22, 2010.^[236]

[317]    These representations for the most part recapitulate positions taken earlier by Oslers on the technical issues. One new issue was the application of the CIF rules with respect to the now abandoned FIE rules.[237] Oslers’ position was that the SLT interests would not have been taxable under the proposed FIE rules in part because the Notes were “cash-settled derivatives” or CSD and not “participating interests”. They argued that the taxpayers were entitled to the benefit of the proposed FIE rules under the CIF rules announced by the government.^[238]

[318]    Following the representations by Oslers in November and December 2010 and before responding to them, the Montreal TSO forwarded the representations to Rulings and consulted with Rulings:

·        Memo dated December 22, 2010 asking for Rulings’ views on the application of the CIF rules to the SLT shareholders;^[239]

·        Memo dated January 7, 2011 asking for Rulings’ views on the availability of a reserve for doubtful debts;^[240]

·        Memo dated January 11, 2011 asking for Rulings’ views on the foreign exchange issue.^[241]

[319]    Oslers made its GAAR submissions on February 3, 2011.^[242]

[320]    The Montreal TSO wrote to Rulings again on March 22, 2011 to provide further argument with respect to the Regulation 7000 issue.^[243] The Montreal TSO maintained its position that the Notes are prescribed debt obligations and not contingent liabilities. They forwarded representations received from Davies on behalf of other SLT shareholders.

[321]    Thomson issued the Sixth TI on April 8, 2011 with respect to the grandfathering rules and the foreign exchange calculation.^[244]

[322]    With respect to grandfathering, Thomson concluded as follows:

·        She supported reassessing the taxpayers under the current OIF rules on the basis that the CIF rules had not been adopted and there was no guarantee that they would be adopted in their current form;

·        If the CIF rules are adopted as drafted, she stated that the proposed FIE rules would apply to the non-CFA taxpayers, and that the non-CFA taxpayers would have to be reassessed under the proposed FIE rules;

·        She concluded that the proposed FIE rules did not apply to the CFA taxpayers, such that they could not invoke the benefit of the CIF rules;[245]

·        She also stated that the proposed FIE rules could not have applied at the level of SLT. It is not clear if she is adopting the argument that the Notes are excluded from the definition of “participating interest” because they are cash-settled derivatives.

[323]    With respect to the foreign exchange calculation, Thomson suggested that the fair market value of the Notes on a particular day should be determined using the exchange rate on that day.

[324]    In its memo to Gibson and Charette dated May 11, 2011 rebutting Osler’s GAAR submissions, the Montreal TSO summarized the effect of the draft CIF rules on its assessing position.^[246] The Montreal TSO’s view was that the draft CIF rules did not affect its assessing position, except that the secondary position for non-CFA taxpayers no longer held. It also acknowledged that the secondary position for the CFA taxpayers no longer held under the proposed FIE rules because the Notes were cash-settled derivatives,[247] but it argued that because there was no inclusion or deduction under the proposed FIE rules for controlled foreign affiliates or cash-settled derivatives, the CIF rules did not technically apply. These same arguments are incorporated in Charette’s rebuttal memo to the GAAR committee dated May 12, 2011.^[248] This position did not give the non-CFA taxpayers the benefit of Thomson’s Sixth TI dated April 8, 2011.

3.3.6    Loss of enthusiasm

[325]    In May 2011, in preparation for the second GAAR Committee meeting in relation to SLT, Armanious invited counsel for the SLT shareholders to a meeting with the Montreal TSO, HQ and Rulings to discuss the issues relating to the SLT audit.[249]

[326]    On May 25, 2011, Oslers wrote to Armanious to respond to the CRA’s positions in relation to the investments in SLT.^[250]

[327]    On May 26, 2011, Armanious forwarded to Oslers five Rulings documents which had not been made public until then.[251] They have never been posted on the CRA’s web site.[252]

[328]    The CRA met with the taxpayers’ counsel on June 3, 2011. At the end of the meeting, Adams said that the Plaintiffs had raised serious concerns and he undertook that the CRA would provide responses in writing to the various issues raised. He said that the Plaintiffs would have the opportunity to make further responsive submissions and that the CRA would not reassess until the responsive submissions had been received and evaluated.[253]

[329]    The second GAAR Committee meeting took place on June 16, 2011. The Committee suggested that CRA and Finance have further discussions and that the Committee would then reconvene to discuss the issue.[254]

[330]    In the summer of 2011, Adams and Jolie, the most senior people in Rulings, became more involved in the SLT audit and start to lose enthusiasm for the assessing positions. Jolie wrote on July 19, 2011:

It is more than likely that the CRA would not succeed in an assessment of the shareholders of SLT.

The ultimate decision on the file would be the result of a series of decisions, each depending on the prior one. While we are comfortable that we have a reasonable argument on any one of the decisions, the cumulative effect points towards failure.[255]

[331]    Gibson expresses concern on August 9, 2011 that Rulings “have never been so bombarded” and “is leaning towards giving up rather than fighting”. She reminds Tremblay that revoking the five opinions issued in the SLT audit would hurt Rulings’ reputation.[256]

[332]    Gibson tries to arrange a meeting with Adams and Jolie. Jolie writes back on August 11, 2011, “It is unlikely that we will have anything at all encouraging to tell you.”[257] On August 12, 2011, Gibson describes Adams as struggling with the question of “whether Reg. 7000 is intended to apply to non-principal protected equity-linked notes like we have.”[258]

[333]    The meeting between CRA and Finance took place on August 30, 2011. Gibson and Charette from the ATP Division met with Ed Short, Nash, Annemarie Humenuk and Witteveen.[259]

[334]    According to Gibson and Charette’s summary, Finance agreed that the Notes are debt obligations and not cash-settled derivatives, and that Regulation 7000 should apply. It was less clear whether Finance agreed with the ATP Division’s position on the CIF rules.

[335]    The CRA had an internal meeting on August 31, 2011 amongst representatives of the Montreal TSO (Armanious, Phisel and Leduc), the ATP Division (Gibson, Charette and Ranger) and Rulings (Jolie, Symes, Albert, Tremblay and Thomson).[260]

[336]    At that meeting, Jolie and Symes from Rulings expressed reservations with respect to the assessing position. Jolie said that he believes that the CRA has a 50/50 chance on each issue, but must win them all.[261] Symes concluded that he was “not so certain” now. Both Armanious and Gibson pushed back. Gibson concludes her notes as follows:

Sherry [Thomson] then asked what we wanted from Rulings. I replied that we had not asked for anything from Rulings, we had already gotten their opinions. Wayne [Adams] had interceded and over the past several months the flurry of activity had been at his request. Phil [Jolie] mentioned that the reps had called Wayne because they wanted HQ input to the file. I reiterated that I had been involved in the file at the reps’ request, I had been responding to the rep’s queries, and had provided information to them on a regular basis. What we wanted was to have Rulings support their previous opinions and to have the Agency speak with one voice. Francois [Ranger] noted that it is a Canada wide voice as Finance and Justice also agree with the positions.[262]

[337]    In her notes, Thomson gives Ranger the last words:

-       at some point Audit will decide what to do. Would be nice to have everybody in Gov’t onside, but may not be possible.[263]

[338]    Jolie testified that he understood the message to Rulings to be “don’t get in the way.”[264]

[339]    In fact, Rulings had very little involvement in the file after the August 31, 2011 meeting. On October 2, 2011, concurrently with his retirement, Adams sent an email to Ranger saying that Rulings would like to continue to be supportive, but suggesting that the matter be resolved by the CRA abandoning its position on Regulation 7000 in exchange for the Plaintiffs winding up their investments in SLT and recognizing the gain in the current year.[265] Ranger rejected that suggestion.[266]

[340]    In December 2011, there was a meeting with Davies to discuss a potential settlement. Davies asked that Jolie be invited. When Gibson relayed the invitation to him on December 16, 2011, Jolie said that the Notes were cash-settled derivatives and were not debt obligations, such that Regulation 7000 did not apply. When Gibson said he was disagreeing with the Rulings’ opinions and with Finance, he said yes. He thought the matter should be settled.[267]

[341]    Thomson closed her file on the same day, “[s]ince nothing more is required from us for the moment.”[268] Tremblay closed his file on January 26, 2012. He stated his conclusion as to whether the Notes are subject to Regulation 7000 as “In our view, they are, but the issue is not clear.”[269]

[342]    Meanwhile, the Montreal TSO proceeded to issue the reassessments in May 2012. The ATP Division remained supportive of the assessing position.

3.3.7    Abandonment of the assessing positions

[343]    After the issuance of the reassessments in May 2012, the Plaintiffs filed notices of objection and two of the Ludmer SLT Plaintiffs filed appeals to the Tax Court as test cases. The appeals started working their way through the Tax Court. The CRA maintained its positions.

[344]    In April 2013, the CRA took the position that the CIF rules “if and when enacted” would not apply to the Plaintiffs, because (1) the Plaintiffs did not include an amount of income under the proposed FIE rules, and (2) the Plaintiffs did not voluntarily comply with the proposed FIE rules.[270]

[345]    Then in May 2014, the CRA made a settlement offer that included abandonment of the SLT reassessments for taxation years ending before March 5, 2010 on the basis of the application of the CIF rules. When the Plaintiffs refused that offer, the CRA consented to all of the appeals.

3.4   Use of the current OIF rules

[346]    The Plaintiffs argue that the CRA applied the wrong rules for taxing foreign investments. The Minister of Finance announced the proposed FIE rules in 1999 and encouraged taxpayers to follow the new rules for ten years, until he announced in 2010 that the new rules would not come into force. The CIF rules dealing with the consequences of the abandonment of the proposed FIE rules were announced in August 2010 and were finally adopted on June 26, 2013.

[347]    The Plaintiffs allege that they acted in accordance with the proposed FIE rules throughout the period, and that they had no income under the proposed FIE rules.

[348]    The Plaintiffs recognize that the current OIF rules were still technically the law in force with the result that the CRA could not legally reassess under the proposed FIE rules but could only reassess under the current OIF rules. However, they argue that seeking to reassess under the current OIF rules without first requesting waivers and thereby forcing a taxpayer to incur an audit under a regime that is meant to be replaced is at the very least unnecessarily burdensome and a violation of the Taxpayer Bill of Rights.

[349]    The Court does not agree with the Plaintiffs.

[350]    It is clear that the OIF rules were the law in force throughout the relevant period and the only rules under which the CRA could reassess the Plaintiffs.

[351]    It is true that the CRA could have asked for waivers until the FIE rules were in force, and then reassessed under the FIE rules. It is also true that in proceeding to reassess under the current OIF rules, the CRA knew or should have known that it would likely have to start over either under the FIE rules when they came into force or under the CIF rules if the proposed FIE rules never came into force.

[352]    However, things do not stop when the Minister of Finance proposes new tax rules. Government must continue to function and to that end the CRA must continue to collect taxes. That is particularly true with the proposed FIE rules, where there was an 11 year delay between their introduction in 1999 and their ultimate abandonment in 2010, and a further 3 years before the CIF rules were adopted. It would be difficult to say that the CRA was unreasonable in not suspending all tax collection with respect to offshore investments for 14 years waiting for the situation to be resolved one way or the other. By the time the bulk of the reassessments were issued in May 2012, the CRA had already waited 13 years. The proposed FIE rules had been abandoned by then and there were proposed CIF rules, but it would be another year before the CIF rules were adopted. There were statute-barred dates in May 2012.[271] The Plaintiffs complain that they were not given a chance to give waivers.[272] At the same time, there is no evidence that the taxpayers offered to give waivers.

[353]    It is interesting to note that Gibson had asked Finance in November 2010 whether it would be premature to issue assessments under the current OIF rules given that the proposed FIE rules had been abandoned in March 2010 and the CIF rules had been proposed in August 2010,[273] and Finance responded as follows:

Presumably, the assessments you are proposing are in accordance with the existing law and ordinary processes available to a taxpayer (e.g., waivers) would be available to the taxpayer. Given that we cannot provide any assurance of when the legislation will be introduced into the House, or enacted, we are not in a position to comment on whether the proposed reassessments could be viewed as premature.[274]

[354]    Rulings had concluded as follows in the Sixth TI dated April 8, 2011:

We agree with your views, and would support your proposal to reassess [under the OIF rules]. Since Finance has abandoned the FIE rules, and will instead rely on the current OIF rules, we conclude that the policy is to assess under the OIF rules where they apply. If, however, the Grandfathering Rules come into force as drafted, and the amount computed under the CRA interpretation of the Accrual Rules is less than the amount computed under the OIF rules, you should be prepared to reassess for the lower amount for the relevant years.[275]

[Emphasis added]

[355]    The situation was not much different in May 2012.

[356]    In all of these circumstances, the Court cannot conclude that the CRA acted prematurely or unreasonably.

[357]    The Court therefore dismisses this argument.

3.5   Application of the current OIF rules

[358]    The Plaintiffs also object to the way in which the CRA applied the current OIF rules. They argue that:

                          i.     The SLT Notes do not qualify as “portfolio investments”

                         ii.     The Plaintiffs did not have a tax-reduction motive

                       iii.     The SLT Notes would not have been taxable under Regulation 7000 if held directly in Canada

3.5.1    “Portfolio Investments”

[359]    Counsel for another SLT shareholder initially put forward the argument that the Notes were not “portfolio investments”.^[276]

[360]    Counsel argued that the Notes are an “investment” but not a “portfolio investment” because (1) “portfolio” implies a multiplicity of assets and not one or two, (2) they were acquired through bilateral negotiation and contract with the borrower and not on the open market, and (3) there is no ready market for the Notes. Moreover, there was not a single trade of the Notes and no manager associated with the Notes.

[361]    The Plaintiffs argue that SLT was not an investment fund because “it was a corporation without employees that held on to two notes for 15 years and did nothing with them.”[277]

[362]    The CRA’s position is that “portfolio investments” has a very broad meaning and corresponds to what would be considered to be a portfolio investment in commercial practice.

[363]    In Gerbro Holdings, the Tax Court concluded that the ordinary commercial meaning of “portfolio investments” in the international investment context was “investments over which the investor does not exercise significant control, but merely wishes to passively benefit from an appreciation in value” or “an investment in which the investor (non-resident entity) is not able to exercise significant control or influence over the property invested in.”[278]

[364]    As a result, the term “portfolio investments” describes the nature of the investments as opposed to the number of investments (that would be “portfolio of investments”) or the number of trades. The lack of employees and activity at the SLT level supports the argument that the Notes are passive investments.

[365]    With that definition in mind, the Court is satisfied that it was reasonable for the CRA to conclude that the Notes are “portfolio investments”. They are investments by SLT in debt instruments of BNSIL and TDII, which are non-resident entities. SLT does not exercise any influence or control over the Notes or the issuers of the Notes. Rather, SLT wishes to passively benefit from the appreciation in value of the Notes.

[366]    In any event, the SLT shares are OIF caught by Section 94.1 ITA if they may “reasonably be considered to derive [their] value, directly or indirectly, primarily from portfolio investments of that or any other non-resident entity”. It is clear that the shares of SLT derive their value indirectly from the Reference Assets.[279] The Reference Assets are a multiplicity of investments held by two non-resident entities, SIL and TDGF, that meet even the narrow definition of “portfolio investments” put forward by the Plaintiffs, such that the SLT shares indirectly derive their value from “portfolio investments of … any other non-resident entity”.

[367]    This argument is dismissed.

3.5.2    Motive Test

[368]    The Plaintiffs argue that they did not have the tax reduction motive required for Section 94.1 ITA. Rather, they argue that their motive for investing in SLT was to get access to the top “superstar” managers.

[369]    The Plaintiffs point to the so-called “Morris letter”, a letter written by T.C. Morris of the Department of Finance on June 13, 1984, at the time of the adoption of Section 94.1 ITA.[280] The Morris letter provides that the intent of Section 94.1 ITA “is not to preclude Canadian taxpayers from making investments in non-resident mutual funds”. It goes on to say:

We recognize, of course, the differences between fixed income debt funds and high risk equity funds. Because of these differences it was assumed that taxpayers who invest in the high risk type funds mentioned in your letter will generally not be affected by these provisions because in this circumstance, the taxpayer is ordinarily not holding equities indirectly rather than directly for tax deferral or avoidance purposes. We believe that the guidelines set out in paragraphs 94.1(1)(c) to (e) of the draft legislation should be helpful in delineating those situations which lack a main tax motivation from those which do.

[Emphasis added]

[370]    The Plaintiffs argue that the investments in SLT were high risk equity funds and that the Morris letter exempts them from Section 94.1 ITA.

[371]    The Court does not accept that broad conclusion. The issue, as pointed out in the Morris letter, is why the taxpayer is holding the investments indirectly through an offshore vehicle as opposed to holding them directly. The nature of the investment is one factor in that determination - if the investment is a highly sophisticated investment such as a high risk equity funds only available through an offshore vehicle, then that suggests that the motive may not be not tax driven. However, if the offshore vehicle is simply holding fixed income debt funds, then it is unlikely that there is any reason to invest in that offshore vehicle unless the investor is seeking to reduce taxes.

[372]    The Plaintiffs argue that the “classic 94.1 case” is where the same investment exists in Canada and offshore and the taxpayer chooses the offshore investment to benefit from lower tax rates.[281] They argue that SLT offered access to a “fund of funds” not available in Canada:

724.      There were no Canadian hedge funds at the time, and Canadians were not permitted to invest directly in American hedge funds. As a result, in order to attract international investors, leading hedge fund managers incorporated funds in offshore jurisdictions. They were almost exclusively located in tax havens in order that investors would not be subject to double-tax (i.e., tax in both the host country of the fund, and in the country of residence of the investor).[282]

[373]    However, the history of SLT shows that the original company, GAMCAN, was incorporated in 1987 in the British Virgin Islands and that its shareholders were restricted to residents of Canada. It could have been incorporated anywhere in the world. The most obvious choice was Canada, given that all of the shareholders were resident there. There was no link to the British Virgin Islands. No evidence was made as to why it was incorporated in the British Virgin Islands. The Plaintiffs offer no explanation. It is not unreasonable to think that the tax consequences were one of the main reasons. As stated by Thomson in the First TI in relation to SLT:

As in Walton, the structure does not identify any compelling reason for the selection of the BVI as a jurisdiction for the incorporation of SLT, save for the tax reduction. It appears that tax reduction was one of the main reasons for the use of the BVI company, if not the main reason. The onus is on the taxpayer to establish that tax reduction was not one of the main reasons for owning the shares (see Roderick W.S. Johnston v. MNR, 3 DTC 1182 (SCC)).[283]

[374]    Thereafter, GAMCAN merged into GAM Multi-Global to form GAM Diversity effective January 1, 1995. That merger was effectively undone in 2001 following the introduction of the proposed FIE rules in February 1999. SLT was the result. At the same time as GAM Diversity was undone, the Notes were interposed between SLT and the Reference Assets - SLT sold all of its Reference Assets to the two banks in exchange for the Notes that would pay the value of the Reference Assets on maturity or on termination. It is clear that this structure was a response to the proposed FIE rules[284] and was an attempt to defer any income until the Notes matured in 2016 or the shareholders sold their shares and to convert any income into capital gains.

[375]    With respect to the purpose test, the auditors referred to the restructuring of GAM Multi-Global in 2001 as evidence that the shareholders had knowledge of a tax advantage and pursued alternative methods to maintain this advantage.

[376]    The Plaintiffs strenuously objected to the CRA relying on the 2001 reorganization to assess the motives of the SLT shareholders. They argue that the 2001 reorganization was done to comply with proposed legislation that they were being encouraged to comply with, and that this should not be held against them. They argue that the CRA had “incredible gall” to rely on the 2001 reorganization as evidence of the Plaintiffs’ motive for the purposes of Section 94.1 ITA.[285]

[377]    The Court notes first that the 2001 reorganization was in no way done to “comply” with the proposed FIE rules. The proposed FIE rules did not require the reorganization. Rather, the reorganization was done in order to maintain certain tax advantages under the proposed FIE rules.

[378]    Moreover, the Court agrees that it would be perverse if the 2001 reorganization, which was designed to produce certain consequences under the proposed FIE rules, produced unintended consequences under the current OIF rules. However that is not what is happening here. The Plaintiffs did not in any way worsen their tax position under the current OIF rules. Rather, it is the attempt to produce certain tax consequences under the proposed FIE rules which is being used as evidence that the shareholders were aware of the tax consequences and had a tax reduction motive.

[379]    The 2001 reorganization makes it clear that SLT and its advisors were not oblivious to the tax issues and that they wanted to ensure that SLT produced the best tax consequences for its shareholders. The shareholders voted in favour of these changes. The fact that SLT and the shareholders and their advisors sought to adopt a structure in 2001 to reduce the tax liability of the shareholders is relevant evidence as to the intention of the shareholders in investing in SLT. The CRA’s position on this issue is not unreasonable.

[380]    The Plaintiffs also argue that the CRA is imposing tax on all of the SLT shareholders without considering their motives individually.

[381]    This is a serious issue. The motive test under Section 94.1 ITA is an individual test. It requires an understanding of why each individual taxpayer made or held a given investment. It may be different for each SLT shareholder. The timing of a shareholder’s decision to invest in SLT will be particularly relevant. For example, a shareholder who purchased shares after the 2001 reorganization may be able to argue that when he purchased his shares, SLT was the only vehicle that allowed him access to the funds held by SLT. The CRA should at least give individual taxpayers the opportunity to explain why they invested in SLT. The CRA pleads that the shareholders had the opportunity to show their personal reasons for investing in SLT, and it points to Sohmer, who was successful in demonstrating that he invested in SLT for business reasons.

[382]    However, this discussion is not relevant to the Plaintiffs. They were among the original shareholders in GAMCAN when it was incorporated in the British Virgin Islands in 1987. Ludmer in particular was very involved in the 2001 reorganization. It is difficult to understand what exactly the Plaintiffs would argue to say that tax consequences were not one of the reasons for the original incorporation in the British Virgin Islands or the 2001 reorganization. They have had ample opportunity to present any relevant evidence and they have not done so.

[383]    The Court concludes that the CRA’s position that Ludmer and Steinberg meet the motive test was reasonable. The matter can be decided by the Tax Court in the remaining appeals.

[384]    That same reasoning might not apply to SLT shareholders who invested after the reorganization or who were not involved in the reorganization or who voted against it. But they are not parties to the present litigation.

[385]    This argument is dismissed.

3.5.3    Regulation 7000

[386]     The CRA applied Regulation 7000 to deem the increase in value of the Reference Assets to be income on the Notes. This was important because the Regulation 7000 income (1) was taxable in the hands of the CFA taxpayers as part of SLT’s FAPI, and (2) was part of the tax reduction motive which allowed the CRA to impute income at the statutory rate to non-CFA taxpayers under Section 94.1 ITA.

[387]    The CRA abandoned the Regulation 7000 argument in 2014. It now argues in the three remaining appeals of non-CFA taxpayers that it is not necessary under Section 94.1 ITA to prove that the taxpayer actually saved taxes by investing in the non-resident entity, and that the actual tax savings are only a factor to be considered in establishing the taxpayer’s motive in making the investment.[286]

[388]    The Court does not agree.

[389]    Section 94.1(1)(d) ITA makes the extent to which the taxes actually paid are significantly less than the taxes that would be payable if the investment was held directly by the taxpayer a factor in assessing motive. That seems reasonable - the bigger the tax savings, the more likely the taxpayer was trying to save tax. But that does not mean that the tax savings are only a factor and that Section 94.1 ITA can apply in the absence of any tax savings. Section 94.1 ITA is an anti-avoidance provision. It cannot apply if no tax is avoided. The CRA cannot deem income under Section 94.1 ITA and collect tax on the investments of an offshore entity where no tax would have been payable if the investment was held directly.

[390]    The Court therefore concludes that the CRA has the burden of establishing that an SLT shareholder would have paid tax if he held the Notes directly. This is where the Regulation 7000 argument comes into play.

[391]    Moreover, the CRA recognized this throughout the audit. There are numerous references to the robustness of the Regulation 7000 argument being key to the assessing position.[287] It was only in 2014 when the Regulation 7000 argument was abandoned that the CRA first suggested that Section 94.1 ITA could apply where no tax would have been payable if the investment was held directly.

[392]    The application of Regulation 7000 to the SLT Notes was hotly contested.

[393]    SLT was structured in such a way that it had little actual income. The Notes themselves did not generate any actual income. SLT had administrative expenses and it redeemed a small portion of the Notes every year to generate some cash to cover those expenses. SLT recognized the gain on the redemption of that small portion of the Notes as income, but that amount was always less than the administrative expenses that SLT paid. As a result, SLT always had less income than expenses and suffered a loss each year. In 2007, the CRA estimated SLT’s loss as averaging US$600,000 per year.[288]

[394]    Instead, the CRA applied Regulation 7000 to deem the increase in value of the Reference Assets to be income on the Notes. In 2007, the CRA estimated the average yearly increase in value at US$93 million.[289]

[395]    The Plaintiffs argued that the effect of this was to convert a small loss into huge gains, and that “the CRA took it upon itself to create a penalizing regime that taxed Canadians on income they did not have, and attributed income to SLT that it did not earn or receive.”[290] They add that “the result achieved by the CRA’s novel approach was absurd” and that “it was entirely devoid of economic or commercial reality.”[291]

[396]    This is very dramatic but simplistic.

[397]    The CRA did not create a penalizing regime. It is not a novel approach. Regulation 7000 does in fact deem annual income where there is no actual income. Its purpose is to prevent the deferral of income through a debt obligation that does not pay any interest until maturity by requiring that a portion of the interest that will be paid at maturity be recognized each year. To that extent, it differs from economic or commercial reality but it is by deliberate choice.

[398]    The issue is whether Regulation 7000 applied to the SLT Notes.

[399]    Regulation 7000 provides for a deemed accrual of interest (which is therefore income) on “prescribed debt obligations”.[292] Regulation 7000(1) defines four categories of “prescribed debt obligation”, two or which are relevant here:

(a) a particular debt obligation in respect of which no interest is stipulated to be payable in respect of its principal amount,

…

(d) a particular debt obligation, other than one described in paragraph (a), (b) or (c), in respect of which the amount of interest to be paid in respect of any taxation year is, under the terms and conditions of the obligation, dependent on a contingency existing after the year,

[Emphasis added]

[400]    Moreover, Regulation 7000(3) specifies as follows:

(3) For the purpose of this section, any bonus or premium payable under a debt obligation is considered to be an amount of interest payable under the obligation.

[401]    Regulation 7000(1)(a) applies to debt instruments that bear no interest but that are sold at a discount, for example a debt instrument that pays $100 with no interest on maturity in two years, which is purchased today for $90. Where Regulation 7000(1)(a) applies, the interest is the difference ($10) between the actual cost of the debt obligation ($90) and the principal amount due at maturity ($100). In the example, there is $10 interest payable in two years, so the annual interest is $5.

[402]    Regulation 7000(1)(d) applies where there is interest (which includes a bonus or a premium), but the amount of interest depends on a contingency. Equity-linked notes are caught by this provision - there is a premium, but the amount of the premium depends on the performance of the reference assets. Where Regulation 7000(1)(d) applies, the interest is “the maximum amount of interest thereon that could be payable thereunder in respect of that year”.

[403]    The CRA’s position in relation to Regulation 7000 in this matter can be summarized as follows:

·        The SLT Notes were “prescribed debt obligations”;

·        The difference between the issuance price and the amount payable at maturity is interest under Regulation 7000(3);

·        Because there is interest stipulated, Regulation 7000(1)(a) does not apply;

·        Because the amount of interest is dependent on a contingency, the value of the Reference Assets at maturity, Regulation 7000(1)(d) applies;

·        “the maximum amount of interest thereon that could be payable thereunder in respect of that year” is the difference between the maximum value of the Reference Assets in that year and the maximum value in the prior years.

[404]    The CRA abandoned that position in 2014, which creates a presumption that the position was wrong. The issue is whether the CRA acted reasonably in the period before 2014 when it maintained that position.

[405]    The Court will examine the reasonableness of the CRA’s position in relation to Regulation 7000 from three angles:

1.    The reasonableness of the position;

2.    The reasonableness of the process by which the position was arrived at; and

3.    The failure to publicize the position.

1. The reasonableness of the assessing position

[406]    The reasonableness of the assessing position must be considered in light of the statutory language and the past practice of the CRA and Finance.

[407]    With respect to Regulation 7000, there are a number of issues raised by Oslers, Davies and counsel for the other SLT shareholders.

·        Prescribed debt obligation

[408]    Counsel for the taxpayers argued that the Notes were not “prescribed debt obligations” to which Regulation 7000 applies. They argue that the Notes were not debt obligations because the principal was not protected and that they were in the nature of equity or cash-settled derivatives.

[409]    The CRA dismissed those arguments. The CRA found that the legal form of the Notes was debt and that they were treated as debt in the financial statements of the banks. The CRA considered that even if the Notes had some features of equity or derivatives, those features were not be sufficient to change the tax treatment.

[410]    The Court finds the CRA’s position on this issue to be reasonable.

[411]    Although the CRA is not bound by the legal form of an arrangement to which the taxpayer is a party, it is difficult for a taxpayer, who has very deliberately and with legal advice given a legal form to a transaction, to argue that the CRA should look through that legal form and treat the transaction differently. That is particularly true where the other party to the transaction has treated the transaction pursuant to its legal form.

[412]    Moreover, the notion of cash-settled derivative is not defined in the ITA. It is not part of the current OIF rules or Regulation 7000 and it is not appropriate to read the words “cash-settled derivative” into the current OIF rules or Regulation 7000. The notion of cash-settled derivative was created by the addition of the words “other than money” to the definition of participating interest in the proposed FIE rules. But it has nothing to do with the definition of prescribed debt obligations under Regulation 7000. It is therefore not clear that the definitions of prescribed debt obligation and cash-settled derivative are mutually exclusive. An instrument could be a prescribed debt obligation for the purpose of Regulation 7000 and be a cash-settled derivative under the proposed FIE rules.

[413]    The CRA struggled with the issue of whether a cash-settled derivative was a prescribed debt obligation under Regulation 7000 in the build-up to the second GAAR meeting in June 2011 and thereafter.[293] The cash-settled derivative issue was discussed at the second GAAR meeting on June 16, 2011, but no one had a clear definition of cash-settled derivative or prescribed debt obligation and the conclusion was to get more advice from Finance.[294]

[414]    Ultimately, a meeting was set up between the CRA and Finance on August 30, 2011.[295]

[415]    By then, the CRA was taking the position that the Notes were not cash-settled derivatives,[296] although they had previously said that they were.[297] At the August 30, 2011 meeting, CRA and Finance agreed that the Notes are debt obligations and not cash-settled derivatives.[298] In its final audit report, the Montreal TSO, basing itself on the meeting with Finance, recognizes that “[n]one of the proposed FIE regime, Section 94.1 ITA or Regulation 7000 apply to a CSD”, but argues that the Notes are not cash-settled derivatives.[299]

[416]    Finally, the past practice of the CRA over a 20 year period was to treat equity-linked notes as prescribed debt obligations subject to Regulation 7000. While it is true that most of these notes are principal-protected in that the holder of the note is guaranteed to receive the principal of the note at maturity and the contingency affects only the bonus that he receives, there are many examples of notes which are not principal-protected and which were treated as prescribed debt obligations subject to Regulation 7000.[300]

[417]    The Court adds that the issue of whether the Notes are debt for the purposes of the ITA was put to the Tax Court in a reference under Rule 58 of the Tax Court Rules. The Tax Court answered that they were:

[133]   In the case of the Notes, the reference question must be answered in the affirmative - that the Notes are debt for purposes of the Act:

(i)            They are entitled Notes. In the Act the word notes is described as a debt obligation or indebtedness. It is also used ejusdem generis as a type of debt such as bonds, debentures and notes et cetera. A note is commonly used to describe a debt in business, commercial and financial markets.

(ii)           They have a maturity which can be triggered early in the event of default or at the Note holder’s option. Upon maturity there is a payment obligation that relates clearly, though in a complex fashion, to the amount for which the Notes were issued, and this payment satisfies the obligation in respect of the issue price.

(iii)          The documents giving rise to and referred to in the Notes describe the amount for which they are issued as a Principal Amount that is the amount advanced by the Note holder to purchase the Note from the issuer in each case, being US $499 million.

(iv)         At maturity, however and whenever triggered, that is whenever payment is required to be made, the amount payable by the issuer under the Notes to the Note holder is readily ascertainable with exact precision. Not only is the method of arriving at the amount clear and certain, the person responsible to the parties for arriving at that precise figure is also clearly set out.

(v)          The interest rate is stipulated in the Notes as it was in the Term Sheets. It is reasonable to consider zero to be an amount for these purposes; loans are often described as “no interest” or “interest-free”. This was presumably set out to make it clear to the parties that there would be no current returns earned or payable. However, the parties did not choose to describe this by reference to distributions of any sort, but limited it to interest.

(vi)         The parties agreed in the Notes that they were to rank pari passu with other debt. The Notes evidence that the parties’ intention was that this be treated like other debt of the issuers. The Notes do not describe this ranking to apply only upon maturity of the Notes.

(vii)        The EAO Notes [the excluded assets owner’s parallel notes], which are also equity-linked notes, are acknowledged in the Notes to be debt for purposes of permitted investments in Reference Assets.

(viii)       The Guarantees provide that the Guarantors would be liable as if they were the primary debtors. The Notes and related agreements do not suggest this is only effective upon maturity of the Notes.[301]

[418]    Even though the question put to the Tax Court was considered by the Federal Court of Appeal not to be sufficiently specific,[302] the Tax Court’s conclusion supports the Court’s view that the CRA’s position was reasonable.

·        7000(1)(a) v. 7000(1)(d)

[419]    Counsel for the taxpayers also argued that, if the Notes were prescribed debt obligations, they fell under Regulation 7000(1)(a) of the Regulation (no stipulated interest) and not Regulation 7000(1)(d) (interest dependent on a contingency).

[420]    Although Charette initially took that position in July 2007,[303] he was quickly corrected by Tremblay.[304] Thereafter, the CRA maintained the position that Regulation 7000(1)(d) applied.[305] Adams raised the question at the second GAAR meeting on June 16, 2011.[306]

[421]    It is clear that there is no express stipulation of interest under the Notes. However, the amount paid at maturity will be different from the amount paid on issuance of the Notes, because it is equal to the value of the Reference Assets, which will change over time. Regulation 7000(3) provides that any bonus or premium payable under a debt instrument is considered to be interest. The CRA treats any additional amount payable at maturity as a bonus or premium and therefore interest. The amount of interest depends on a contingency, namely the value of the Reference Assets at maturity. The Notes therefore fall within Regulation 7000(1)(d).

[422]    That position is perhaps more obvious in the case of a principal-protected note, where the holder receives back the principal and an additional amount which can easily be qualified as a bonus or premium. Where the note is not principal-protected, the holder receives an amount which may be greater or less that the original amount. But where the amount is greater, it is reasonable to qualify that amount as a bonus or premium.

[423]    This is consistent with the way that the CRA treated other equity-linked notes, where there was a bonus or premium payable at maturity calculated in function of the change in an index or in the value of a stock or bundle of stocks. The CRA treated that bonus or premium as interest which was contingent on the change in an index or in the value of a stock or bundle of stocks. As a result, it applied Regulation 7000(1)(d) to those notes.

[424]    Further, there are many examples of notes which are not principal-protected and they have been treated by the CRA in the same way as principal-protected notes.[307]

[425]    The Court finds the CRA’s position on this issue to be reasonable.

·        Accrual of interest under Regulation 7000(2)(d)

[426]    The next argument put forward by the counsel for the SLT shareholders is that, even if the increase in the value of the Notes over their term is interest, the final value is not known until maturity and therefore the “maximum amount of interest that could be payable thereunder in respect of that year” cannot be calculated until maturity.

[427]    Thomson initially came to that conclusion with respect to the SLT Notes in the First TI. As discussed above, the ATP Division and the auditors then consulted Tremblay, who was in a different branch at Rulings. He concluded that the Notes were taxable on an accrual basis.

[428]    The basis for that conclusion evolved. In the Second TI,[308] Tremblay focused on the right of the SLT shareholders to redeem their shares on the last Monday of each calendar month. The put price is based on the value of the Reference Assets. Since the value of the Notes is directly related to the value of the Reference Assets, this means that the value of the Notes can be readily determined each month.

[429]    In the Fifth TI,[309] Tremblay focused instead on the “inside put” - SLT’s right to terminate each Note by providing 367 days prior written notice to the issuer of the Note, such that here is a factual possibility that the Notes could be terminated in any year other than the first year.

[430]    These arguments must be evaluated in light of the statutory language and the past practice of the CRA and Finance.

[431]    Under Regulation 7000(2)(d), the deemed interest is equal to “the maximum amount of interest that could be payable thereunder in respect of that year”.

[432]    From a technical perspective, the outside put is problematic. The outside put is not a feature of the Notes but is found in the by-laws of SLT. It provides that SLT shareholders have the right to put their shares to SIL, another foreign subsidiary of BNS, for a price equal to the proportionate share of the market value of the Reference Assets at the time of exercise of the put. The outside put does not touch the Notes and does not involve the issuer of the Notes. It is difficult to see how SLT can be said to receive a bonus on the Notes because a SLT shareholder makes a profit by redeeming his shares in SLT.

[433]    Where the noteholder had the possibility of selling the note on a secondary market organized by the issuer of the notes, there are fewer technical issues. The transaction in those cases relates to the notes and not any shares. However, there was no contractual right to sell the notes and no contractual obligation to buy them, such that the sale was not pursuant to the notes and the increased value is not under the notes.

[434]    The inside put avoids some of the technical pitfalls of the outside put and the secondary market in that it involves the Notes and not the shares. Further, the payments would be made directly by the issuers of the Notes to the holder of the Notes pursuant to the Notes.[310]

[435]    As for the fact that the Notes were not actually redeemed, Regulation 7000(2)(d) refers to “the maximum amount of interest that could be payable thereunder in respect of that year” [emphasis added]. If the Notes were redeemed and the amount was paid, there would be no need to deem income under Regulation 7000. We are necessarily dealing with contingencies and things that did not happen. With the SLT Notes, the maximum amount that could be payable in the year can be calculated because it is the value of the Reference Assets, and those values are tracked.

[436]    As a result, the “inside put” theory appears to be consistent with the language of Regulation 7000(2)(d).

[437]    However, it is not consistent with the past practice of the CRA with equity-linked notes.

[438]    Rulings issued a series of opinions that equity-linked notes are not taxable on an accrual basis but only on maturity, unless the taxpayer has the right to lock in the return before maturity and exercises that right.[311] The mere fact that something could have been done to crystallize the value was not sufficient with other notes.

[439]    This conclusion was reached in connection with secondary markets, where the mere existence of the secondary market was not enough to deem income under Regulation 7000. There were also difficulties in those cases in calculating the amount. The CRA also considered notes where the noteholder has the right to lock-in the bonus at any time during the life of the note. In those circumstances, the CRA decided that, if the noteholder exercised that right, the amount was known with certainty and could accrue on an annual basis. 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. The mere possibility was not enough.

[440]    The Court concludes that the arguments put forth to justify the annual accrual of interest on the SLT Notes under Regulation 7000 represent a significant break from the prior practice of the CRA on equity-linked notes that cannot be justified by any distinction between the Notes and the prior equity-linked notes. Essentially, the CRA applied an assessing position to the SLT shareholders that it did not apply to any other taxpayer.[312]

2. The reasonableness of the process

[441]     The Montreal TSO discovered SLT in the context of the RPI.

[442]    It found a small group of Canadian taxpayers making a lot of money through an offshore investment vehicle and not declaring any income or paying any tax on it until maturity in 15 years. Moreover, by selling the shares shortly before maturity, the taxpayers could realize a capital gain, only half of which was taxable. In other words, the structure would defer the payment of tax and convert the income into a capital gain.

[443]    The Montreal TSO was entitled to view this structure as one that merited close examination.

[444]    The Montreal TSO took steps to uncover the facts. In particular, it obtained copies of the filings with the Québec, Ontario and British Columbia securities regulators and it obtained documents from BNS and TD to understand the SLT structure and the profits that it was earning, identify the other shareholders of SLT, and ensure that they were properly declaring their interest in SLT and their income from SLT.

[445]    It then formulated a preliminary position on the taxation of the SLT investments.

[446]    The Montreal TSO did not act on its own. It very reasonably brought this structure and its preliminary views to the attention of the ATP Division for confirmation. The ATP Division is a headquarters division with specialization in aggressive tax structures.

[447]    Further, the ATP Division acted reasonably in inviting Thomson from the International Section of Rulings to the initial meeting with the Montreal TSO and asking Thomson for an opinion. In that process, and throughout their dealings with Rulings, the Montreal TSO and the ATP Division provided Rulings all of the submissions made by Oslers, Davies and counsel acting for other SLT shareholders as well as their memos.

[448]    The first process issue relates to the Thomson opinion. The ATP Division and the Montreal TSO did not agree with the conclusion on Regulation 7000 in the First TI issued by Thomson. They immediately consulted another officer in Rulings, Tremblay, and asked for his opinion on Regulation 7000.

[449]    The Plaintiffs are very critical of this request for a second opinion.[313] They say that it is opinion shopping.

[450]    In the Second TI, Tremblay refers to the First TI and suggests that he had new information that was not available to Thomson when she drafted the First TI:

Upon the submission of more detailed information, we noticed that the shareholders of SLT can demand once a month to receive the value of the shares (i.e., the shareholders can redeem their shares) and the Put Facility Provider must acquire the shares at fair market value which is based on the value of the Notes which is in turn based on the value of the Reference Assets.[314]

[451]    This explanation is not convincing. Thomson did in fact have the description of the put in the materials provided to her for the preparation of the First TI.[315] She simply did not give it the importance that Tremblay did.

[452]    A second justification given by the CRA witnesses and hinted at in the Second TI[316] is that Thomson was an officer in the International Section of the International and Trusts Division, whereas Tremblay was an officer in the Corporate Financing Section of the Financial Sector and Exempt Entity Division. Regulation 7000 relates to the taxation of debt instruments and is not typically an international taxation issue. Regulation 7000 happens to arise in the international context in this matter because SLT was offshore. Moreover, Tremblay had written previous opinions on the application of Regulation 7000 to equity-linked notes. In fact, when Charette questioned Thomson about her interpretation of Regulation 7000 in the First TI, she said that she would “check with the Corporate Finance people here at Rulings who are responsible for Reg 7000”[317] and she called Tremblay.[318] When she reported back to Charette, she added, “Claude says you are welcome to discuss the issue with him if you wish.”[319]

[453]    As a result, it was reasonable for the ATP Division and the Montreal TSO to assume that Tremblay had more expertise than Thomson in relation to Regulation 7000, to submit the question to him and to rely on his advice.

[454]    In early 2009, the SLT audit expanded to include other SLT shareholders, including the Plaintiffs.[320] The Montreal TSO requested information from those shareholders[321] and made requests to foreign tax authorities. Proposal letters were issued to Ludmer and the Ludmer Plaintiffs on May 8, 2009[322] and to Steinberg and the Steinberg Plaintiffs on June 22, 2009 based on the Tremblay Second TI.[323] Letters were also sent to other taxpayers on the same basis.

[455]    At this point, Oslers started making representations to the CRA to counter the proposed assessment. Other law firms were also involved, making representations on behalf of their clients. The Montreal TSO analyzed these representations and sent them to the ATP Division and to Rulings.

[456]    Cracks started to show in the CRA’s position in the summer of 2010. Symes became involved in the file at Rulings, and the result is that in the Fifth TI dated June 29, 2010, Rulings abandoned the outside put theory in favour of the inside put. At about the same time, Justice issued an opinion that seems to have rejected the outside put theory.

[457]    The process goes further off the rails, however, in June 2011 when the second GAAR meeting defers a decision and Rulings begins to express doubts about its previous opinions. The ATP Division first tries to bully Rulings into maintaining its opinions. In a conversation with Tremblay, Gibson “questioned what revoking five opinions would do to Rulings reputation”,[324] and in a meeting with Jolie, Symes, Albert, Tremblay and Thomson, Gibson said that “we had not asked for anything from Rulings, we had already gotten their opinions” and “[w]hat we wanted was to have Rulings support their previous opinions”.[325] When that did not work, Rulings was simply excluded from the process.

[458]    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.

3. The failure to publicize the position

[459]    A further factor which is very troubling is the CRA’s decision not to publicize its position in the SLT file and in particular not to post the six technical interpretations in the SLT file on its website.[326] It seems that Tremblay was not even aware that his technical interpretations had not been published.[327] The technical interpretations were not available to the TSOs.[328] The CRA did not even send the technical interpretations to the Plaintiffs’ counsel until May 2011.[329]

[460]    This decision was justified by Albert as based on the CRA’s obligation not to disclose information about a taxpayer who is either named or identifiable. The argument is that there was too much information identifying SLT and that if the CRA removed it all the letter would not be comprehensible.[330]

[461]    The Court does not accept this explanation. The SLT Notes can be described in generic terms that do not identify SLT. To the extent that the technical interpretations represent a departure from the CRA’s practice with respect to equity-linked notes, they were of interest to all participants in the Canadian equity-linked note market. It appears to the Court that the decision not to publish the SLT technical interpretations was based on the concern that they were not consistent with the CRA’s prior practice in relation to equity-linked notes and the CRA did not wish to change its general practice in relation to equity-linked notes.

[462]    The publicity issue goes back at least to June 2008. After issuing the Second TI, which relied on the outside put, Tremblay arranged a meeting with Finance on June 11, 2008 to discuss principal-protected notes where there was a secondary market. Witteveen wrote him a few days after the meeting to express a concern about the impact of the Second TI:

FSP [Financial Services Policy Division] is concerned because they do not want this to look like finance is closing down the PPN, which they think plays a valuable role. Therefore we would like to set up a new meeting with you and FSP to discuss how to proceed.[331]

[Emphasis added]

[463]    Finance issued a memo on October 30, 2008 which emphasizes the potential impact of the Second TI:

We consider the CRA’s interpretation of the interest accrual rules in this case to be reasonable because the investor can determine the amount of the gain accrued at any particular time. We therefore have no reason to question the CRA’s decision to tax this particular type of PPN on an accrual basis. We note that the interpretation that the CRA proposes to apply in this ruling may affect some existing debt obligations held by individual Canadian retail investors. We anticipate that both these investors and Canadian banks would react negatively to the ruling. The Canadian Bankers Association has proposed that the interpretation in this ruling be applied on a prospective basis; however it is generally not possible for the CRA to apply an interpretation of existing provisions in this manner.[332]

[Emphasis added]

[464]    It would appear that the CRA was attempting to avoid the difficulties that this change in practice would represent by limiting it to SLT and keeping it secret. If that was its intent, it succeeded in that financial institutions continued to issue equity-linked notes without regard to the Second TI.

[465]    However, the lack of publicity suggests that the CRA knew that it was treating the SLT Notes differently and that it wanted to treat the SLT Notes differently. This is not acceptable. The consistent application of taxation law is a fundamental principle set out in the Taxpayer Bill of Rights. This is clearly unreasonable.

3.6   The CRA did not give the Plaintiffs the benefit of the CIF rules

[466]    The third major complaint about the assessing position is that the CRA did not give the Plaintiffs the benefit of the CIF rules.

[467]    A bit of background.

[468]    In 1999, the government proposed to replace Section 94.1 ITA with a set of rules called the Foreign Investment Entity or FIE rules.

[469]    The proposed FIE rules were carried forward from budget to budget but were never adopted by Parliament.[333]

[470]    Finally, in the 2010 budget released on March 4, 2010, the Minister of Finance announced that he was abandoning the proposed FIE rules in favour of “limited enhancements” to the current OIF rules in Section 94.1 ITA.[334]

[471]    However, for the previous 11 years, the CRA had encouraged taxpayers to structure their affairs and declare their income on the assumption that the proposed FIE rules would eventually be enacted retroactively to 1999. The abandonment of the proposed FIE rules could potentially cause prejudice to taxpayers who had relied on that assumption.

[472]    As a result, the government announced in the 2010 budget that a taxpayer who had voluntarily complied with the proposed FIE rules before March 4, 2010 would be taxed under the proposed FIE rules for those years.[335]

[473]    The legislative proposals effecting this result were included in the coming-into-force or CIF provisions for the amendments to Section 94.1 ITA in the 2010 budget. The proposed CIF rules were announced on August 27, 2010[336] and were modified in 2012.[337] The CIF rules came into force on June 26, 2013.[338]

[474]    There are therefore two interrelated issues:

·        How the SLT shareholders would have been taxed under the proposed FIE rules; and

·        If the SLT shareholders would pay no tax, or less tax, under the proposed FIE rules than under the current OIF rules, whether the SLT shareholders benefit from the CIF rules.

3.6.1    The proposed FIE rules

[475]    The proposed FIE rules would apply to a taxpayer who owns a “participating interest” in a “foreign investment entity” which is not an “exempt interest”.

[476]     Under the definitions in the proposed FIE rules, it is clear that shares are a “participating interest” and that SLT is a “foreign investment entity”. The shares in SLT should be covered by the proposed FIE rules.

[477]    An interest in a controlled foreign affiliate is an “exempt interest” such that the proposed FIE rules do not apply to an interest in a CFA. This means that the FAPI rules, as modified (in particular Element C was to be modified), continue to apply to interests in a CFA.

[478]    For non-CFA taxpayers, the proposed FIE rules were intended to replace the motive test. Motive is no longer relevant. Non-CFA taxpayers who own a “participating interest” in a “foreign investment entity” would be taxed on that investment without regard to their motive.

[479]    However, instead of being required to include a notional return on the investment, the taxpayer has the option of including in his income for the year one of the following three amounts:

1.    a notional return on his investment calculated by multiplying his cost by a notional return (similar to the calculation under the current Section 94.1 ITA)

2.    the “mark to market” return, which represents the difference in the market value of the investment from one year to the next; or

3.    his share of the income of the foreign entity, computed as if the foreign entity was resident in Canada (similar to the FAPI rules).

[480]    SLT had been restructured in 2001 with these rules in mind: SLT was intended to have no income, so that the shareholders could elect the third option and have a nil inclusion.

[481]    The issue of whether the reorganization achieved that result is the exact same Regulation 7000 debate under the proposed FIE rules as under the current OIF rules, and it should have the same result.

[482]    The Montreal TSO’s secondary position for non-CFA taxpayers under the current OIF rules, was that it could consider the gains on disposition, interest and dividends on the Reference Assets. This position was not available under the proposed FIE rules, because the proposed FIE rules do not include the notion of the income earned on portfolio investments of “any other non-resident entity”.

[483]    For the CFA taxpayers, FAPI continued to apply. Definition A of FAPI leads right back to the same Regulation 7000 argument.

[484]    The secondary position under definition C of FAPI is more complicated. Definition C requires the calculation of SLT’s income as if it were resident in Canada. In the FIE scenario, this requires the application of the proposed FIE rules at the SLT level. The issue is therefore whether the Notes are a “participating interest” in a “foreign investment entity”.

[485]    The Montreal TSO took the position that the Notes are a participating interest in the issuers, which are foreign investment entities, and the issuers’ FAPI is the gains on disposition, interest and dividends from the Reference Assets.

[486]    Oslers argued that the Notes are not participating interests because they are cash-settled derivatives, and that the issuers are not foreign investment entities.

[487]    This lead to a big debate as to whether the Notes are cash-settled derivatives.

[488]    Again some background is necessary.

[489]    The definition of “participating interest” in the proposed FIE rules prior to 2003 was as follows:

"participating interest", of a particular entity or individual in a non-resident entity, means

(a)  if the non-resident entity is a corporation, a share of the capital stock of the corporation;

(b)  if the non-resident entity is a trust, an indefeasibly vested interest as a beneficiary under the trust;

(c)  if the non-resident entity is not a corporation or trust, an interest in the non-resident entity; and

(d)  a property that is convertible into, exchangeable for, or confers a right to acquire, directly or indirectly,

(i)            An interest, described in any of paragraphs (a) to (c), in the non-resident entity; or

(ii)           A property the fair market value of which is determined primarily by reference to the fair market value of an interest, described in any of paragraphs (a) to (c), in the non-resident entity.

[490]    Based on that definition, Rulings concluded on April 24, 2003 in technical interpretation E2003-0008355 (unrelated to SLT) that an option agreement sharing some characteristics with the Notes was a participating interest subject to the proposed FIE rules:

It appears that the option right granted to the Trust by the Canadian bank under the Agreement fits into the above proposed definition of "participating interest" in that the option right is a property that confers a right to acquire directly a property (Canadian funds) the fair market value of which is determined primarily by reference to the fair market value of an interest (securities and other financial products) in the non-resident entities. Thus, in our view, the option right so granted to the Trust under the Agreement constitutes a participating interest as that term is defined in the proposed subsection 94.1(1) of the Act in the Draft Legislation.[339]

[Emphasis added]

[491]    Finance reacted to the technical interpretation with a letter dated June 27, 2003, referred to as the Farber letter:

However, these proposals are not intended to apply to a right to acquire only cash, even where the amount of cash to which the right holder may be retitled is determined by reference to the fair market value of a participating interest in a non-resident entity. While other forms of derivative transactions may fall within the scope of the FIE proposals, this form of cash-settled derivative transaction is not intended to be subject to the FIE proposals as presently drafted.

This is not to suggest that there are no tax policy concerns arising out of derivative or synthetic transactions to defer or avoid Canadian tax. Indeed, we share your concerns and we intend to review the related issues in conjunction with your officials. However, these concerns are broadly based and not limited to the avoidance of income through foreign intermediaries.[340]

[Emphasis added]

[492]    Moreover, the definition of “participating interest” in the proposed FIE rules was amended on October 30, 2003 to add the words “(other than money)” immediately after the word “property” in paragraph (d)(ii), such that paragraph (d)(ii) now reads:

"participating interest", of a particular entity or individual in a non-resident entity, means

…

(d)  a property that is convertible into, exchangeable for, or confers a right to acquire, directly or indirectly,

…

(ii)    A property (other than money) the fair market value of which is determined primarily by reference to the fair market value of an interest, described in any of paragraphs (a) to (c), in the non-resident entity.

[Emphasis added]

[493]    Rulings immediately withdrew its earlier technical interpretation on November 7, 2003.[341]

[494]    This is the genesis of the cash-settled derivative issue. The Farber letter and the second technical opinion both use that expression to describe the instruments carved out of the definition of “participating interest” in the proposed FIE rules.

[495]    The issue in this case is whether a cash-settled derivative could be a prescribed debt obligation under Regulation 7000 and is discussed above.

[496]    The CRA initially took the position that the Notes were cash-settled derivatives, with the result that they were not “participating interests” under the proposed FIE rules. However, to the CRA, this meant that the Plaintiffs could not claim the benefit of the CIF rules because the proposed FIE rules did not apply to the Notes.[342]

[497]    Oslers agreed that the Notes were cash-settled derivatives, but argued that the result is not only that they are not “participating interests” under the proposed FIE rules, but also that they are not “prescribed debt obligations” under Regulation 7000 and therefore not taxable under either regime. Further, that raised a question as to whether a cash-settled derivative could be caught by anti-avoidance legislation.[343]

[498]    The Court has already concluded that the Notes are prescribed debt obligations under Regulation 7000, whether or not they are also cash-settled derivatives.

[499]    The issue at this stage is whether the Notes are a “participating interest” in a “foreign investment entity” under the proposed FIE rules.

[500]    The Notes are not shares or an option to acquire shares in the issuers. Moreover, it is not clear that the issuers qualify as “foreign investment entities”.

[501]    The Notes are a contractual right to acquire the value of the Reference Assets, which might include shares or interests in non-resident entities. As such, they might fall within the definition of participating interest in those entities.

[502]    However the “other than money” exception clearly applies.

[503]    As a result, the Notes are not “participating interests” under the proposed FIE rules.

[504]    The result is therefore that under the proposed FIE rules, the taxation of the CFA and non-CFA taxpayers is entirely dependent on Regulation 7000. With the Court’s conclusion that the CRA’s interpretation of Regulation 7000 is unreasonable given the clear break from past practice, it follows that the taxation of the SLT shareholders under the proposed FIE rules would also be unreasonable.

3.6.2    CIF rules

[505]    Essentially, the objective of the CIF rules is to give a taxpayer who voluntarily complied with the proposed FIE rules in the years prior to March 4, 2010 (the date on which the proposed FIE rules were abandoned) the benefit of those rules by taxing him under the proposed FIE rules. This was a matter of fairness, which flowed from the fact that the Minister and the CRA had encouraged taxpayers to comply with the proposed FIE rules from 2001 to 2010.

[506]    The Minister announced in his budget speech on March 4, 2010 that there would be CIF rules. The first proposed CIF rules were released on August 27, 2010. They were revised on October 19, 2012 and they came into force on June 26, 2013.

[507]    Each version of the CIF rules sets out two conditions for the taxpayer to get the benefit of the proposed FIE rules:

·        The taxpayer must have included or deducted an amount under the proposed FIE rules in computing income for the prior taxation years; and

·        The taxpayer must file the prescribed form before his filing-due date for the taxation year in which the CIF rules receives royal assent.

[508]    In its November 2010 submission on the proposed FIE rules, Oslers stated that the Plaintiffs approached tax reporting for their investments in SLT for taxation years 2002 and following on the basis that they were subject to the proposed FIE rules; that they opted to report their proportionate share of SLT’s income; that SLT had no income and that they were therefore required to and did in fact report income of nil in respect of their investments in SLT. Oslers added that the Plaintiffs intended to avail themselves of the right to perfect their reporting of income under the proposed FIE rules as soon as the necessary legislation was enacted.[344]

[509]    In the Sixth TI, dated April 8, 2011, Thomson appeared to agree that the non-CFA taxpayers were covered by the CIF rules.[345] The Montreal TSO seemed to take the same position in its final report.[346]

[510]    However, in April 2013, the Minister took the position that the CIF rules “if and when enacted” would not apply to the Plaintiffs, because (1) the Plaintiffs did not include an amount of income under the proposed FIE rules, and (2) the Plaintiffs did not voluntarily comply with the proposed FIE rules.[347]

[511]    This position is not reasonable.

[512]    The clear intent of the CIF rules was to afford some level of protection to taxpayers who had arranged their affairs and paid tax on the assumption that the proposed FIE rules would come into force with retroactive effect. It is not their fault that the Minister ultimately abandoned the proposed FIE rules.

[513]    The extrinsic evidence is clear that the Plaintiffs were very much aware of the proposed FIE rules and that they voted to restructure SLT in such a way as to ensure that the proposed FIE rules would not result in adverse tax consequences for the SLT shareholders.

[514]    The CRA took the position that it would look only at the tax return and not the extrinsic evidence, and that there was nothing in the tax return to indicate that the taxpayer was filing under the proposed FIE rules. In other words, the CRA is now requiring (although it did not publicize any such requirement at the time) that taxpayers insert a note in their tax returns indicating that they were availing themselves of the proposed FIE rules. The election form that the CRA was to make available to taxpayers was not yet available at the time.

[515]    This position is not fair. It is an attempt by the CRA to deny the benefit of the CIF rules in circumstances where the CIF rules clearly are intended to be available.

[516]    The CRA ultimately gave the Plaintiffs the benefit of the CIF rules and vacated the reassessments for the years covered by the CIF rules, namely 2001 to Match 2010. But that did not happen until 2014.

3.7   The final reassessments were unreasonable and had no chance of success

[517]    The Plaintiffs argue that the final reassessments were unreasonable and had no chance of success, and that they took the strongest assessing positions in order to get maximum leverage for settlement. The particular matters that the Plaintiffs complain about are the following:

·        Applying mutually inconsistent provisions on a year by year basis depending on which generated a higher tax for the year

·        Applying the wrong foreign exchange calculation;

·        Ignoring losses;

·        Taxing statute-barred years; and

·        Taxing two different shareholders for the same increase in value of the same shares.

3.7.1    Mutually inconsistent provisions

[518]    The Plaintiffs allege that the CRA applied on a year by year basis whichever of two alternative positions triggered the larger tax liability for the year, with the result that certain of the Plaintiffs were being reassessed on $11,000,000 more income than they could possibly be assessed under either one of the alternative positions.

[519]    The Plaintiffs are correct. With respect to each CFA taxpayer, the CRA had two positions for the calculation of FAPI: Element A and Regulation 7000, or Element C and Section 94.1 ITA. The CRA calculated the income inclusion for each year according to each assessing position, and then it included the higher one for each year in the final reassessment. It explained the process as follows:

On a protective basis, yearly reassessments are based on the greater of Reg. 7000 or Element C (i.e. the Minister will be arguing both positions) until the issue is settled by a court.[348]

[520]    This position leads to an unfortunate outcome for the Plaintiffs of a total reassessment for an amount higher than the total reassessment under either Element A or Element C alone.[349]

[521]    It nevertheless appears to the Court to be a reasonable approach for the CRA to take to ensure that the amount of the reassessment represents the maximum amount of tax possibly owing, in order to protect the tax base. Otherwise, when the final determination is made that one position or the other is correct, the CRA will not be able to collect the full amount of tax for certain years.

3.7.2    Foreign exchange

[522]    To put the debate on foreign exchange into context, it is important to understand how the CRA calculated the deemed annual interest under Regulation 7000.

[523]    The CRA based its calculation of the deemed annual interest under Regulation 7000 on the maximum value of the Notes in each year. If the maximum value increased from one year to the next, the difference was treated as accrued interest. If the value decreased from one year to the next, there was no income or loss for that year. If, in the following year, the maximum value was higher than the maximum value in the last year in which tax was payable, the difference was accrued interest. An adjustment would be made in the year of maturity if the highest value of the Reference Assets on which tax was paid was higher than their value at maturity.

[524]    The result was that at maturity, the SLT shareholder would have paid taxes on the increases in value from the original purchase price to maturity on a year by year basis, instead of paying tax on the full increase in the year of maturity.

[525]    The difficulty lies in the exchange rate, since most of the Reference Assets were in U.S. dollars and tax is payable on amounts in Canadian dollars.

[526]    The Plaintiffs argue that the value of the Reference Assets from year to year, converted at the time into Canadian dollars, declined, such that no tax should be payable.

[527]    The auditors took the position that the value of the Reference Assets in U.S. dollars increased. The auditors then converted the increase in value in U.S. dollars from year to year into Canadian dollars.

[528]    The result of this difference in the foreign exchange calculation is huge: the auditors calculated total income over the years of $434 million for all SLT shareholders using its methodology, whereas Rulings calculated total income over the years of $44 million using the Plaintiffs’ methodology. The auditors also calculated a foreign exchange loss of $389 million to be applied at maturity.[350]

[529]    The auditors consulted with Rulings on this issue. Rulings issued the Sixth TI on April 8, 2011 in which it suggested that the fair market value of the Notes on a particular day should be determined using the exchange rate on that day.^[351]

[530]    The auditors did not follow the advice from Rulings but rather assessed the Plaintiffs by using their original methodology. It appears that they never told Rulings that they were doing this.[352]

[531]    The result is unreasonable. Canadian taxpayers pay Canadian taxes on their income in Canadian dollars. If there is a fluctuation in exchange rates, it should be taken into account immediately, while the interest is being accrued, and not at the end of the transaction. Moreover, the Montreal TSO should not ignore the advice that it received from Rulings, who are supposed to be the experts, without a good reason. No good reason was put forward.

3.7.3    The CRA ignored losses

[532]    The Plaintiffs allege that the CRA deemed sales and repurchases of its assets at their highest theoretical value each year to create taxable gains while at the same time ignoring any losses.

[533]    The CRA pleads that this the use of the highest theoretical value during the year is required by Regulation 7000(2)(d), which states that the deemed interest is equal to “the maximum amount of interest thereon that could be payable thereunder in respect of that year”.

[534]    Moreover, Regulation 7000(2)(d) does not ignore losses: if the maximum value in one year is lower than the maximum value in the preceding year, no interest is deemed to accrue in that year, and no interest will accrue in any subsequent year until the maximum value in that year exceeds the last maximum value which lead to an accrual of interest. If the interest accrued during the term of the note exceeds the actual increase in value, there is an over-accrual which can be deducted on disposal of the note.[353]

[535]    It therefore appears that in this regard the CRA was applying the ITA correctly, or at least reasonably.

3.7.4    Taxation of statute-barred years

[536]    The Plaintiffs also argue that the CRA applied Regulation 7000(2)(d) in such a way as to include the increase in value of the Note in the taxation years prior to 2005 in the reassessments for taxation year 2005. In his testimony, Leduc recognized that this is what the CRA had done.[354]

[537]    This is particularly important because most of the increase in value of the Notes occurred prior to 2005. The Plaintiffs argue that the value decreased from 2005 to 2009.

[538]    It is difficult to understand how Regulation 7000(2)(d), which provides for the inclusion in income of “the maximum amount of interest thereon that could be payable thereunder in respect of that year” [emphasis added], can be interpreted in such a way as to include increases in value from previous years. The CRA made no attempt to explain this.[355]

[539]    The Court concludes that the interpretation was unreasonable.

3.7.5    Double taxation

[540]    Moreover, the Plaintiffs argue that there is an instance of double taxation where SLT shares were transferred by one Plaintiff to another but the CRA reassessed both of them for the deemed income for 2001 to 2006.

[541]    3421848 acquired its shares in SLT from 4077211 in 2006. If the CRA was right in the way in which it applied Regulation 7000, 3421848 should have paid tax in 2007 on the increase in value of the Reference Assets from 2006 to 2007. Instead, the CRA used an increase in value of the Reference Assets that included the increase in value prior to 3421848’s acquisition of the shares, with the result that 3421848 was assessed tax for a period when it did not even own the shares in SLT.[356]

[542]    Meanwhile, 4077211 was also assessed tax on the same increase in value.

[543]    This is clearly wrong. The CRA does not question that.

[544]    However, the CRA argues that it would have made the correction if this had been raised.

[545]    The Court finds a mistake but no fault.

3.8   Conclusion on assessing positions

[546]    Based on all of the foregoing, the Court concludes that the CRA was at fault in taking an unreasonable final assessing position on the following issues:

·        Its interpretation of Regulation 7000 was inconsistent with its prior (and subsequent) position with respect to similar instruments issued by financial institutions in Canada;

·        Its interpretation of Regulation 7000 to include the increase in value of the Notes in taxation years prior to 2005 was unreasonable;

·        Its position denying the application of the CIF rules was inconsistent with the clear evidence; and

·        Its calculation of foreign exchange was inconsistent with the position of Rulings and resulted in a much higher amount of income from year to year.

[547]    The Court also finds a mistake, in that the CRA’s calculation of income for 3421848 in 2007 includes the increase in value of the Reference Assets during a period when 3421848 did not own the shares in SLT. 4077211 owned the shares during those years and that income was also attributed to 4077211.

4.    Failure to give notice of final reassessments

[548]    In the course of the meeting with the CRA on November 25, 2010, Oslers provided two draft notices of application.^[357] The first dealt with the proposed reassessments and would prohibit the CRA from (1) reassessing until the CIF rules are enacted, (2) taking the 2001 reorganization into account in the motive test, (3) issuing a reassessment inconsistent with the CRA’s published administrative practice regarding Regulation 7000 or its treatment of other taxpayers, and (4) imposing penalties in relation to the Form T1134B. The second draft notice of application dealt with access to information issues.

[549]    In response to the draft notices of application, Gibson undertook that the Plaintiffs would be given five days’ notice before any proposed reassessment to allow the Plaintiffs to present their applications, if they wished to do so.

[550]    The CRA subsequently met with the taxpayers’ counsel on June 3, 2011. After the taxpayers’ counsel presented their positions on all of the issues, Adams undertook that the CRA would provide responses in writing to the various issues that were raised. He said that counsel would then have the opportunity to make further responsive submissions and that the CRA would not reassess until the responsive submissions had been received and evaluated.

[551]    The CRA served a multitude of final reassessments in May 2012. The Montreal TSO chose to reassess at that time because there were statute-barred dates coming up. There is no evidence, however, that it asked for waivers pending the adoption of the CIF rules. Moreover, the CRA did not provide the five days’ notice, as promised in November 2010. It never provided the responsive submissions, as promised in June 2011. The Montreal TSO asked Ranger on April 26, 2012 to notify Oslers,[358] but he did not do so. The only explanation was that he forgot. A letter of apology was sent on June 29, 2012.[359]

[552]    This is not acceptable. Undertakings given by the CRA are serious matters. The Plaintiffs acted in reliance on the undertaking in November 2010 in that they did not file the draft applications that they had prepared, but instead waited for the notice that never came. The CRA argues that the application for judicial review to prevent the issuance of reassessments would undoubtedly have failed as the validity of reassessments falls within the exclusive jurisdiction of the Tax Court.[360] That is not relevant. The CRA did not do what it promised to do. The Plaintiffs lost the opportunity to present those applications before the reassessments. They also lost the opportunity to offer waivers.

[553]    This is a fault by the CRA.

5.    “Criminal tax matter” letter

[554]    On August 9, 2012, the CRA wrote to the relevant authorities in Bermuda seeking to obtain information from Harbour Fiduciary Services Limited, the administrator of SLT, about the shareholders of SLT.[361] The CRA’s theory was that Harbour had information about the shareholders of SLT and that Ludmer had access to this information. This evidence would support its position that Ludmer had sufficient information to know that SLT was a controlled foreign affiliate of certain of his related companies, and that he should therefore pay substantial penalties for his failure to file Form T1134B.

[555]    In the course of the exchanges with the Bermudan authorities, the CRA indicated that the request was in relation to a “criminal tax matter”.[362] It is clear that this was a very serious error. The CRA admitted as much when it withdrew the request and apologized to Ludmer and to other SLT shareholders.

[556]    The CRA argues that the error was a result of a mistake by Luc Rochefort, an employee within the Exchange of Information Services division. The Plaintiffs argue that Rochefort’s mistake was part of a deliberate attempt by the CRA (1) to obtain information by illegal means, and (2) to hurt Ludmer and the other Plaintiffs.

[557]    It is necessary to review the circumstances surrounding the request.

[558]    Rochefort received an email from Leduc on July 24, 2012 that included a draft request for information form for Bermuda.[363] At that time, Rochefort was already working on requests to Ireland and the Netherlands relating to SLT audits.[364]

[559]    Leduc’s draft was largely correct. It refers in box 8 to there being more than 160 shareholders “under examination”, and in Box 11 it says that the purpose for which the information is requested is “determination, assessment and collection of taxes”. However, there is some ambiguity in that Leduc refers to a court case in box 6 and states in box 12 that “We are investigating the shareholders” of SLT. In this context, “examination” generally refers to an audit and “investigation” has more of a criminal connotation. Moreover, Leduc requested information from 2007 to 2012. The information exchange agreement with Bermuda[365] came into force on July 1, 2011, and pursuant to Article 12 of the agreement, the request for information could only go back to 2007 if it related to a criminal investigation. If the request related to an audit, it could only cover the period after July 1, 2011.

[560]    When he reviewed the draft, Rochefort changed “examination” to “investigation” in box 8 to make it consistent with box 12 and he changed “determination, assessment and collection of taxes” in box 11 to “recovery and enforcement of tax claims”.[366]

[561]    Rochefort testified that he made these changes because he believed that the SLT matter was a criminal case. He did not check with Leduc when he made these changes because Leduc was retiring from the CRA on August 15, 2012 and Phisel was taking over the file.[367] Phisel did not get involved with the request until October 29, 2012.[368]

[562]    The request for information, as revised by Rochefort, was approved by his supervisor Anne LeRoy and was signed by Sue Murray, the Director of the Competent Authority Services Division.[369]

[563]    The request that Bermuda received was not clear:

·        It referred to a court case in box 6;

·        It referred to an “investigation” and “investigating” in boxes 8 and 12;

·        The tax purpose was identified as “recovery and enforcement of tax claims” in box 11, but there was no box on the form next to the following option “investigation or prosecution of tax matter”; and

·        The time period in relation to which the information was sought is 2007 to 2012.

[564]    As a result, the Bermudan authorities wrote Rochefort on August 28, 2012 with a number of questions, including the following:

Please advise us if this request should be treated as a Civil tax matter request or a Criminal tax matter request as Box 11 suggest it is a Civil tax matter request.[370]

[565]    Rochefort replied the same day, again without consulting Phisel or anyone else:

I apologize for any inconsistencies in our request. I hope that the following information clarifies things for you:

1.    It is a criminal matter as the Canadian taxpayers are under investigation.

…[371]

[566]    The Bermudan authorities accepted his answer as forming part of the initial request and proceeded on that basis.[372]

[567]    Rochefort’s answer is clearly wrong. There was never any criminal investigation in relation to SLT. He was clearly negligent: he should have known from his prior involvement sending requests for assistance in the SLT matter that it was a civil matter, and he should have known that Leduc and Phisel were auditors. Moreover, if he had any doubt, he should have called Phisel to confirm the status of the matter. He did not speak to anyone before sending his reply. He simply got caught up with the reference to a court case in box 6 and the use of the words “investigation” and “investigating” in boxes 8 and 12, seemingly forgetting that he had substituted “investigation” for “examination” in box 8, to conclude that there must be a criminal investigation ongoing. His time entry dated October 29, 2012 states:

The request from the TSO did indicate “court case” and that “we are investigating”…[373]

[568]    The CRA is clearly liable for the damages that Rochefort’s mistake caused to any of the Plaintiffs. The Court will consider that issue below. In that context, the fact that the CRA corrected its mistake relatively quickly once it learned of it[374] and that the CRA apologized[375] will be factors.

[569]    The Plaintiffs invite the Court to go further and conclude that Rochefort’s mistake was part of a deliberate attempt by the CRA (1) to obtain information by illegal means, and (2) to hurt Ludmer and the other Plaintiffs.

[570]    There is no evidence to support either conclusion. Rochefort did not know Ludmer or the other Plaintiffs. He had no reason, on his own, to obtain information illegally or to hurt them. Other than the exchange of emails with Leduc at the beginning of August, there is no evidence of any communications between Rochefort and anyone else who might have instructed him to mislead the Bermudan authorities. The Plaintiffs cross-examined Rochefort, Leduc, Phisel and almost everyone else involved in the audit and they did not elicit any evidence of communications from any of them. The internal memos of the CRA do not indicate any communication.[376]

[571]    In the circumstances, the Court characterizes Rochefort’s mistake as negligence or even gross negligence for which the Defendants are liable, but the Court declines to characterize it as intentional with the additional consequences that such a characterization might bring.

6.    Sandringham

6.1   Background

[572]    The circular sent to the GAMCAN shareholders describing the proposed merger of GAMCAM and GAM Multi-Global on November 8, 1994 described certain payments as follows:

If the Plan of Merger is approved and implemented, Mr. Arnold Steinberg and Mr. Irving Ludmer, until recently directors of Gamcan, will be invited by Global Asset Management Limited, London, the Investment Advisor of Multi-Global, to join an advisory committee in respect of Multi-Global. Companies in which they have an indirect interest will be paid a fee by a company within the GAM group.[377]

[573]    Ludmer and Steinberg incorporated Sandringham in Bermuda in 1995 as the vehicle for receiving these payments.[378] The structure was that Sandringham was owned 50% by Browning Limited and 50% by Kensington Gardens Ltd.[379] Browning was owned by Berkeley Trust, whose beneficiaries were members of the Ludmer family. Kensington was owned by Eaton Place Trust, whose beneficiaries were members of the Steinberg family. Sandringham, Browning, Kensington, Berkeley Trust and Eaton Place Trust were all non-residents.[380] Sandringham, Browning and Kensington each received an undertaking by the Bermudan government that it would be exempt from all income, withholding or capital gains taxes until March 28, 2016.[381]

[574]    Sandringham entered into an agreement with GAM Multi-Manager Advisors Limited (“GAM Multi-Manager”),[382] another GAM company, on July 20, 1995 whereby Sandringham agreed to provide the following “investment consultancy services” to GAM Multi-Manager or any other GAM entity, for ten years with automatic one-year renewals, in exchange for a fee:

2.1        Newco [Sandringham] will provide investment consultancy services to GAM [GAM Multi-Manager] or, at the request of GAM, to any other GAM Entity, in respect of Multi-Global, at such times as shall be mutually convenient. The investment consultancy services shall consist primarily of the identification of potential investment managers, the evaluation of the performance and suitability of such managers and advice concerning the selection of and removal of managers, the allocation of assets under management among managers and the mix of investments.[383]

[575]    The fee payable to Sandringham was an amount equal to the difference between the GAM Multi-Global fees and the GAMCAN fees payable by the GAM Multi-Global shareholders who either were shareholders of GAMCAN prior to January 1, 1995 or had been introduced by Sandringham after January 1, 1995.

[576]    Sandringham and GAM entered into a further agreement on July 12, 1999 entitled “Reimbursement Out of Pocket Expenses Agreement”,[384] whereby a percentage of any “excess” out of pocket expenses charged to GAM Diversity (later SLT)[385] was payable to Sandringham. The percentage corresponded to the percentage of the GAM Diversity shareholding held by shareholders who either were shareholders of GAMCAN prior to January 1, 1995 or had been introduced by Sandringham after January 1, 1995.

[577]    The 1995 and 1999 agreements were replaced by two agreements between GAM and Sandringham dated November 30, 2001.[386]

[578]    Under the first agreement, Sandringham agreed to provide “consultancy services” described as follows to GAM:

2.1        Sandringham will provide consultancy services to GAM or, at the request of GAM, to any other GAM Entity, in respect of the Reference Assets, at such times as shall be mutually convenient. The consultancy services shall consist primarily of the identification, evaluation and introduction of pre-eminent investment management professionals, including those specializing in processes and procedures relating to “back office” operations, due diligence and operational management and risk. Such identification, evaluation and introduction services may extend to persons specializing in legal, accounting and security endeavours, the whole to foster the activities and responsibilities of GAM towards the Reference Assets.

[579]    Under the second agreement, Sandringham agreed to provide essentially the same services as under the first agreement (the last four words of Section 2.1, “towards the Reference Assets”, are omitted).

[580]    The term under both agreements was 10 years with automatic one-year renewals. The fee under the first agreement is similar to the fee under the original 1995 agreement. The fee is increased by 0.15% (the base fee retained by GAM is reduced by that amount) and is payable on all shareholdings, because GAM Diversity now has only Canadian shareholders. The fee under the second agreement is an additional fee calculated on the shareholdings of Kensington and Browning and any of their associates or affiliates.

[581]    Sandringham also entered into an agreement with Harbour on November 30, 2001.[387] Under this agreement, Sandringham agreed to render certain consultancy services:

2.1        Sandringham will provide consultancy services to the Administrator or, at the request of the Administrator [Harbour], to any other service provider, in respect of the Company [GAM Diversity] and, in particular, with respect to the management of the procedures and other duties of the Administrator contemplated by the Reference Asset Management Agreement.

[582]    This agreement also had a ten-year term with automatic one-year renewals. The agreement required Harbour to remit to Sandringham any subscriber fees it received from new shareholders. Sandringham later agreed to share those fees with Sherbrooke Financial Services (2001) Inc. and Belvedere Asset Management Limited if those firms introduced new shareholders to SLT.[388]

[583]    The total fees paid to Sandringham between 1995 and 2007 were $104,425,882.[389]

[584]    The Sandringham structure was Canadianized in 2007:

·        4431472[390] and 4431481[391] were incorporated with Ludmer and Steinberg respectively as their sole shareholders;

·        Avon Trust[392] and Thames Trust[393] were established in Alberta for the benefit of Ludmer and his family and 4431472;

·        Portsmouth Trust[394] and Bloomsbury Trust[395] were established in Alberta for the benefit of Steinberg and his family and 4431481;

·        the Sandringham agreement was terminated[396] and GAM entered into new agreements to pay the fees to Thames Trust[397] and Bloomsbury Trust;[398]

·        the GAM monies accumulated in Berkeley Trust ($70,051,640) and Eaton Place Trust ($72,636,582) were repatriated to Canada through Avon Trust and Portsmouth Trust to Ludmer and members of the Steinberg family respectively. No tax was paid on the repatriation of the monies;[399]

·        Sandringham, Kensington and Browning were dissolved and Berkeley Trust and Eaton Place Trust were terminated.[400]  

[585]    The new agreements with Thames Trust and Bloomsbury Trust simply require GAM to make the payments. They do not provide for any services to be rendered by Thames Trust or Bloomsbury Trust.

[586]    At the end of April, 2011, Thames Trust and Bloomsbury Trust filed amended returns for taxation years 2007 to 2010,[401] and 4431472 and 4431481 filed amended returns for taxation years 2008 to 2010.^[402] 4431472 and 4431481 filed amended returns for taxation year 2011 on June 7, 2012.^[403] Pursuant to these amended returns, 4431472 and 4431481 requested refunds of the $9 million they had paid to the CRA and the Agence du revenu du Québec for taxation years 2008 to 2011.

6.2   Audit and proposed assessments

[587]     On June 14, 2010, the Montreal TSO requested information in relation to the paragraph of the GAMCAN merger document that referred to Steinberg and Ludmer being invited to join an advisory committee in respect of GAM Multi-Global and fees being paid to companies in which they have an indirect interest.[404]

[588]    On November 25, 2010, Oslers provided its response.[405] Oslers explained the Sandringham structure and confirmed that GAM had paid more than $100 million to Sandringham between 1995 and 2007, when the Sandringham structure was terminated. Oslers explained that no tax was payable because the payments were not fees for services. Oslers added that amounts paid by GAM after 2007 have been reported for Canadian tax purposes as fully taxable in the hands of 4431472 and 4431481.[406]

[589]    The initial request for information was sent by Armanious and the replies were sent to him. But as of August 2011 at the latest, the Sandringham matter had been taken over by a new audit team made up of Zucker and Ordonselli, who were not involved in the SLT audit.

[590]    There were further exchanges through November 2012, and a meeting on October 26, 2012.[407] Zucker and Ordonselli were present for the CRA at the October 26, 2012 meeting.

[591]    By February 2013, they indicated that they would be issuing proposal letters the following month. It seems that the file was now being run by Gibson, Charette and Dawn Dannehl of the ATP Division.

[592]    The proposal letters were finally sent on May 16, 2014.[408]

[593]    In the proposal letters, the CRA took the position that the income earned by Sandringham from 1995 to 2007 and by Thames Trust and Bloomsbury Trust after 2007 was taxable and should have been reported by Ludmer and Steinberg in their Canadian tax returns under Section 56(2) ITA. The CRA indicated that it was reviewing the possible application of Sections 94(1) and 160 ITA.

[594]    The CRA further took the position that it was entitled to reassess years back to 1995, which would normally be statute-barred under Section 152(4) ITA, because Ludmer and Steinberg had made “misrepresentations attributable to wilful default”.

[595]    The additional income from 1995 to 2011 was approximately $89 million for each of Ludmer and Steinberg.

[596]    Finally, the CRA was proposing gross negligence penalties under Section 163(2) ITA equal to 50% of the amount of unpaid tax on the omitted income.

[597]    The Plaintiffs allege that the total bill, including taxes back to 1995, penalties and interest, was $130 million against each of Ludmer and Steinberg personally.

[598]    After some further back and forth between the parties, the CRA filed a further series of proposal letters dated June 22, 2016 in which it maintained its position and added the following:

·        It added Section 246(1) ITA as a further basis for taxing Ludmer and the Steinberg estate;[409] and

·        With respect to the distribution of the assets of Berkeley Trust and Eaton Place Trust to Ludmer and members of the Steinberg family in 2007 through Avon Trust and Portsmouth Trust, it proposed to tax both the transferees and the transferors under Sections 160 and/or 94 ITA.[410]

[599]    The CRA continues to seek penalties. The Plaintiffs claim that these new positions add $15 million of interest.

[600]    The Plaintiffs contest the positions put forward by the CRA. They argue:

1.    There was no basis for taxing the GAM payments;

2.    There was no basis for taxing statute-barred years; and

3.    There was no basis for imposing gross negligence penalties.

[601]    Meanwhile, the CRA has not dealt with the refunds requested by 4431472 and 4431481 for taxation years 2008 to 2011, despite repeated requests by 4431472 and 4431481.[411]

6.3   Analysis of the assessing positions

·        Preliminary comment

[602]    The context in which the Court will review the CRA’s assessing position in the Sandringham audit is very different from the context in which it reviewed the CRA’s assessing positions in the SLT audit.

[603]    The CRA abandoned its assessing positions in SLT in May 2014, creating a presumption that the assessing positions were wrong. On the other hand, the CRA maintains its assessing positions in the Sandringham audit, which are very different from its assessing positions in SLT.[412] Not only is there no presumption that they are wrong, but the ITA presumes that assessing positions are correct. Further, and unless the Court decides to put an end to the audit, this is an ongoing matter in which the parties have not yet exercised their right to go to the Tax Court for a judgment on the validity of the CRA’s assessing positions. While such a judgment is not an essential precondition to the Court finding that the CRA has committed a fault, it would be dangerous for the Court to decide that a position taken by the CRA which has not been tested in the Tax Court (or abandoned by the CRA) is unreasonable. The Court will do so only in a clear case.

·        Section 56(2) ITA

[604]    Section 56(2) ITA provides essentially that a payment which the taxpayer directs to a third party is taxable as if received directly by the taxpayer.

[605]    There are four conditions for Section 56(2) ITA to attribute income to a taxpayer:

1.    There must be a payment to a person other than the taxpayer;

2.    The payment must be made pursuant to the direction of the taxpayer or with his concurrence;

3.    The payment must be for the benefit of the taxpayer, or the taxpayer must desire to confer the benefit on the other person; and

4.    The payment would have been included in the taxpayer’s income if it had been made to the taxpayer.

[606]    In its letters dated May 16, 2014, the CRA argues that these four conditions are met:

1.    The payments are made to Sandringham, or later to Thames Trust and Bloomsbury Trust;

2.    Ludmer and Steinberg created Sandringham and the trusts and directed that the payments be made to them;

3.    Ludmer and Steinberg were the ultimate shareholders of Sandringham and the beneficiaries of the trusts, and they (and family members) received the benefit of the payments;

4.    The payments would have been taxable if received directly by Ludmer and Steinberg as property income or business income.

[607]    Oslers argues that Section 56(2) ITA does not apply, and that the inclusion of statute-barred years and penalties is baseless:

1.    There was no transfer of property from Ludmer and/or Steinberg to Sandringham or the trusts because they never had any right whatsoever to payments from GAM and therefore could not have transferred anything;

2.    The payments from GAM to Sandringham and the trusts were not income. They reflected the “glow” that attached to Ludmer and Steinberg, but were not tied to any services or property. The payments even continued after Steinberg’s death;

3.    The notion of including otherwise statute-barred years in any reassessments was baseless. Ludmer and Steinberg acted on the advice of tax counsel, and never made any misrepresentations attributable to wilful default; and

4.    The notion of gross negligence penalties is equally baseless, as there was no knowing or grossly negligent falsity reported by Ludmer or Steinberg.[413]

[608]    In support of its position, Oslers filed the opinion of Donald Bowman, the former Chief Justice of the Tax Court, dated June 25, 2014.[414] The Plaintiffs subsequently filed the opinion of Karen Sharlow, a retired judge of the Federal Court of Appeal and now counsel at Oslers, dated August 11, 2016,[415] and after the trial provided the CRA with the opinion of Marshall Rothstein, a retired judge of the Supreme Court of Canada, dated May 5, 2017.[416]

[609]    The filing of the Bowman opinion and the reference in it to “the legal advice received jointly by Ludmer and Steinberg from one of Canada’s most respected law firms” lead the CRA to argue that Ludmer and Steinberg had waived privilege in “all tax and/or legal advice Mr. Arnold Steinberg and Mr. Irving Ludmer jointly or separately may have received”, stretching back to 1995.[417] To resolve that debate, Oslers offered to provide a statement from Davies attesting that it had advised Ludmer and Steinberg between 1995 and 2004 on Canadian income tax matters relating to Sandringham, and in particular on the non-application of the ITA with respect to the GAM payments.[418] The CRA did not accept that offer,[419] but did not pursue the waiver issue.

[610]    Bowman essentially made two arguments. First, he argued that the payments are reputational payments arising in a non-business circumstance and are therefore “nothings” for Canadian tax purposes. They would not have been taxable even if received directly by Ludmer and Steinberg. He also argued that Ludmer and Steinberg never had the right to receive the payments and therefore could not transfer the right to Sandringham. The CRA rejected Bowman’s arguments.[420]

[611]    With respect to the nature of payments, the Supreme Court established in Stewart v. Canada that the issue is whether the taxpayer is undertaking the activity in pursuit of profit and in accordance with objective standards of businesslike behaviour, or whether the activity is a hobby or other personal pursuit.[421] It summarized the analysis as follows:

60         In summary, the issue of whether or not a taxpayer has a source of income is to be determined by looking at the commerciality of the activity in question.  Where the activity contains no personal element and is clearly commercial, no further inquiry is necessary.  Where the activity could be classified as a personal pursuit, then it must be determined whether or not the activity is being carried on in a sufficiently commercial manner to constitute a source of income.[422]

[612]    The GAM payments appear to be commercial in nature, given their magnitude, periodicity and regularity, and given that they are made between arm’s length parties in a business and property relationship. The 1994 letter refers to them as fees and the 1995 contract provides that they are fees paid for “investment consultancy services”, which are carefully defined in the agreement, even though it appears that no services were actually rendered. There does not appear to be any hobby or other personal pursuit involved.

[613]    The Federal Court of Appeal in Canada v. Johnson, referred to the so-called Cranswick list of factors to assist in determining whether a particular amount is income from a source or a non-taxable receipt or windfall:

[614]    The GAM payments were not in the nature of a windfall. They were made pursuant to a contract. They were enforceable, organized, foreseeable and customary since 1995. As for the final Cranswick factor, the contracts provided for services to be provided as consideration for the payments. Against this, Oslers argues that the payments were not solicited by Ludmer or Steinberg, but rather that they were offered by de Botton, and that Sandringham never provided any services. However, Oslers recognized that de Botton wanted to ensure that Ludmer and Steinberg would remain invested in GAM Diversity after the 1995 merger,[424] which may be sufficient consideration.

[615]    The argument put forward by Bowman that they are “nothings” for Canadian tax purposes because they are merely reputational payments arising in a non-business circumstance may ultimately be upheld by the Tax Court, but it is not so clear at this stage as to render the CRA’s position unreasonable.

[616]    Moreover, the Court has difficulty with Bowman’s argument that there was no transfer because Ludmer and Steinberg never had the right to receive the payments and therefore could not transfer the right to Sandringham. There seems to be an inconsistency in arguing that the payments were for Ludmer and Steinberg’s reputation but that Ludmer and Steinberg had no right to the payments. Further, GAM and de Botton were dealing with Ludmer and Steinberg and not with Sandringham, and the Sandringham structure was proposed by Ludmer and Steinberg’s legal advisors[425] for the sole purpose of receiving the payments which otherwise would have been received by Ludmer and Steinberg personally.

[617]    As for the issue that the payments continued after Steinberg’s death, the Court notes that Steinberg died in 2015, well after the Sandringham agreements had been replaced by new agreements with Thames Trust and Bloomsbury Trust which did not provide for any services to be rendered. This can hardly assist in the interpretation of the Sandringham agreements.

[618]    The Court therefore concludes that the CRA’s position on the taxation of the GAM payments under Section 56(2) ITA is not unreasonable.

·        Section 246(1) ITA

[619]    Section 246(1) ITA is the tax avoidance provision dealing with indirect payments. It was put forward by the CRA in June 2016 as an alternative position for taxing Ludmer and Steinberg personally on the GAM payments.

[620]    The conditions for the application of Section 246 ITA are as follows:

1.    A person confers a benefit, either directly or indirectly, by any means whatever, on a taxpayer;

2.    The amount of the benefit is not included in the taxpayer’s income or taxable income earned in Canada under Part I; and

3.    The amount would be included in the taxpayer’s income if the amount of the benefit were a payment made directly by the person to the taxpayer.

[621]    The CRA argues that GAM is conferring a benefit indirectly on Ludmer and Steinberg that would have been included in Ludmer and Steinberg’s income if the payment had been made directly by GAM to Ludmer and Steinberg.

[622]    This position is subject to the same arguments as the Section 56(2) ITA position. The Court therefore concludes that the CRA’s position is reasonable.

·        Sections 94 and 160 ITA

[623]    Section 94 ITA deems a non-resident trust to be a resident of Canada for the purposes of computing the trust’s income and determining its liability for tax if the non-resident trust or a controlled foreign affiliate of the non-resident trust acquired property directly or indirectly from a Canadian-resident beneficiary (1995 to 2007) or any Canadian resident (after 2007).

[624]    Section 160 ITA provides that where a taxpayer transfers property not at arm’s length, the transferee and the transferor are jointly and severally liable for the value of what was transferred.

[625]    The CRA argues that Ludmer and Steinberg are resident beneficiaries of Berkeley Trust and Eaton Place Trust and that they transferred their right to receive payments directly to Sandringham and indirectly to its shareholders, Berkeley Trust and Eaton Place Trust. Berkeley Trust and Eaton Place Trust are therefore treated as residents of Canada under Section 94 ITA, and Ludmer and Steinberg are jointly and severally liable with Berkeley Trust and Eaton Place Trust under Section 160 ITA for the tax they are required to pay, up to the maximum amount of the distributions received by Ludmer and Steinberg.

[626]    Again the fundamental issues are the nature of the payments and whether there was a transfer by Ludmer and Steinberg of the right to receive the payments, and the arguments set above apply.

[627]    The CRA advances one further argument in that Berkeley Trust and Eaton Place Trust received dividends from Browning and Kensington respectively, and that these are taxable dividends even if the GAM fees received by Sandringham are not taxable (which the CRA does not concede).

[628]    Oslers filed the Sharlow letter dated August 11, 2016[426] in response to the proposal to tax Berkeley Trust under Section 94 ITA and then Ludmer and Avon Trust under Section 160 ITA.

[629]    Sharlow argues that the proposal is wrong in fact and in law. The arguments that she advances are similar to those made by Bowman two years earlier - the payments are not income to Ludmer because he was not required to do anything, and there was no transfer because Ludmer never had a legal right to the payments. She also argues that Section 94(2)(k) ITA cannot apply because GAM and Sandringham dealt with each other at arm’s length.

[630]    The Court set out above its analysis of the first two issues. As for the Section 94(2)(k) ITA argument, the transfer under review is from Ludmer to Sandringham, which is not at arm’s length, and not the transfer from GAM to Sandringham.

[631]    For these reasons, the Court is not prepared to label the CRA’s position on Sections 94 and 160 ITA as unreasonable.

6.4   Taxation of statute-barred years and gross negligence penalties

[632]    The CRA took the position that under Section 152(4) ITA it was entitled to reassess years back to 1995 which would normally be statute-barred, because Ludmer and Steinberg had made “misrepresentations attributable to wilful default”.

[633]    The CRA was also proposing gross negligence penalties under Section 163(2) ITA equal to 50% of the amount of unpaid tax on the omitted income.

[634]    In his submission, Bowman emphasizes that Ludmer and Steinberg acted on legal advice and he concludes as a result that there could be no misrepresentation by Ludmer or Steinberg that would justify opening up a statue barred year or imposing penalties.

[635]    The legal advice is clearly relevant in assessing whether Ludmer and Steinberg made “misrepresentations attributable to wilful default”. The CRA asked to review the legal advice received by Ludmer and Steinberg in order to assess the argument on opening up a statue barred year and imposing penalties.[427] This lead to a back and forth between the CRA and Oslers as to whether a summary of the legal advice would be sufficient.[428] The CRA never received either the opinions or the summary.

[636]    Ludmer and Steinberg knew that these very substantial payments were being made and that no tax was being paid. The payments were never disclosed to the CRA until the CRA started asking questions in 2010, 15 years after the payments started. It is also interesting that taxes were paid after the structure was Canadianized in 2007.

[637]    It is fair to infer that their lawyers created the Sandringham structure and drafted the contracts and that they advised Ludmer and Steinberg that they were not required to pay any tax. However, the legal advice was not produced and therefore the facts on which the advice was based and any limitations on the advice are not before the Court. Moreover, there is also the issue of the contracts which state that Sandringham was receiving the payments in consideration for “investment consultancy services”. Ludmer and Steinberg now argue that no such services were ever provided and it was never the intention to provide such services, suggesting that the contracts were shams. Ludmer and Steinberg must have known that the contracts were shams. It is difficult to reconcile the sham contracts with legal advice.

[638]    In these circumstances (very substantial payments, no tax, no disclosure, sham contracts and reliance on legal advice not produced), and subject to the comments below in the section entitled “Settlement offer”, the Court is of the view that the CRA’s position on opening up statute-barred years and penalties is not unreasonable.[429] It will be for the Tax Court to decide.

7.    Settlement offer

7.1   Background

[639]    On May 27, 2014, Justice made a global settlement offer to Ludmer.[430]

[640]    The settlement offer included the following elements:

1.    Abandonment of the SLT reassessments for taxation years ending before March 5, 2010 on the basis of the application of the CIF rules;

2.    Discontinuance of the Tax Court appeals;

3.    Discontinuance of the present action in Superior Court;

4.    Discontinuance of the access proceedings in Federal Court;

5.    Reassessment of Ludmer for the Sandringham payments under the May 16, 2014 letter, except that gross negligence penalties would not be assessed; and

6.    Possible application of Sections 94 and 160 ITA to the Sandringham payments abandoned.

[641]    There was no delay for the acceptance of this offer, but the CRA stated that, in order to permit a constructive settlement dialogue, Ludmer must agree within three days to suspend all litigation for 60 days, failing which the proposal would automatically expire. This timing is important because the CRA had a delay until May 30, 2014 to respond to some follow-up questions in the discovery process in the Tax Court litigation.

[642]    Ludmer allowed the three day delay to expire without agreeing to suspend all litigation.

[643]    On May 30, 2014, Justice filed motions to suspend the timetable order in the Tax Court litigation on the basis that Justice “has been instructed to consent to judgment in the appeal[s].”[431]

[644]    Oslers opposed the motions, arguing that the CRA should be obliged to answer the follow-up questions.[432] The Tax Court nevertheless suspended the timetable orders.[433]

[645]    There were some settlement discussions between the parties, but no agreement was reached.[434]

[646]    When discussions failed, Justice announced on June 17, 2014 that it would file consents to judgment in the two pending tax appeals. It added that the CRA was prepared to process the Plaintiffs’ objections in accordance with the CIF rules for taxation years ended before March 4, 2010.[435]

[647]    The Plaintiffs interpreted this as a tactical move to end the only two appeals and thereby terminate the Plaintiffs’ discovery rights without resolving the status of the other taxpayers. They refused to consent to the filing of the consents to judgment and on June 19, 2014 they filed appeals on behalf of all the other taxpayers for all relevant years[436] and they sought to have all of the appeals consolidated.[437]

[648]    Ultimately, the appeals were consolidated and all of the appeals for the years ending before March 4, 2010 were allowed by consent.[438] In the three remaining appeals, the CRA abandoned its position on Regulation 7000, arguing instead that the motive test under Section 94.1 ITA applied without the need to prove any income.

7.2   Allegations and analysis

[649]    The Plaintiffs allege that the settlement offer was made in bad faith in an attempt (1) to extract amounts that the CRA knew were not due, and (2) to avoid having to respond to a discovery request.

[650]    The Plaintiffs allege that the CRA knew in May 2014 that it was wrong on the SLT reassessments and that it would have to abandon them, but that instead of simply abandoning them it offered to abandon them in exchange for concessions by the Plaintiffs.

[651]    In the same way, the Plaintiffs allege that the CRA rushed to make the Sandringham proposal and included in it the statute-barred years and the penalties in order to give it leverage to negotiate a global settlement and to increase the pressure on the Plaintiffs to settle. As evidence of this, they cite the fact that the settlement offer included dropping the penalties that had been part of the proposal only a few days earlier.

[652]    Finally, the Plaintiffs argue that the timing of all of this was to avoid having to respond to some follow-up questions in the discovery process. Those responses were due May 30, 2014 and the settlement offer made on May 27, 2014 was conditional on the Plaintiffs agreeing within three days to suspend all litigation.

[653]    The circumstances surrounding the offer tend to support the Plaintiffs’ allegations, at least in part.

[654]    It is clear that by May 27, 2014, the CRA had decided that it would abandon its reassessments of the Plaintiffs in respect of SLT. That conclusion is supported by the fact that Justice advised the Tax Court on May 30, 2014 that it had been instructed to consent to judgment in the two Tax Court appeals.

[655]    Can the CRA use as a bargaining chip in settlement negotiations a position that it knows to be wrong?

[656]    It is a question of degree. The Taxpayer Bill of Rights provides that taxpayers have the right “to pay no more and no less than what is required by law”. The Court does not take this to mean that the CRA can only ever claim the exact amounts that it is certain are due under the law, and that it therefore can never settle for less than payment in full of the amount that it claims. The CRA can take an aggressive position in which its chances of success are less than 100% and it can settle for less than it is claiming if the taxpayer persuades the CRA that it is wrong in fact or in law.

[657]    That is not what happened here. The SLT reassessments might have been characterized as aggressive in the early years, but by May 2014 the CRA had decided to abandon them. The settlement offer was an attempt to extract concessions from the Plaintiffs in exchange for abandoning a position that the CRA knew that it would abandon anyways. That is not how the CRA is supposed to operate. If it has a position that it knows it must abandon, it should do so without attempting to extract concessions.

[658]    In that context, the timing of the Sandringham proposal is problematic.

[659]    The file was dormant from February 2013 to May 2014. Suddenly, on May 16, 2014, the proposal letters were issued without any advance notice. Zucker testified that he was instructed to issue the proposal letters quickly.[439] They were issued before the CRA had completed its review of the possible application of Sections 94(1) and 160 ITA. There is clearly an element of rush.

[660]    The proposal letters were severe: they covered 20 years, set aside statute-barring and included gross negligence penalties. The threatened reassessments totalled approximately $130 million for each of Ludmer and Steinberg, including $80 million in interest dating back to 1995 and $33 million in gross negligence penalties.[440]  The proposal letters give Ludmer and Steinberg 30 days to respond. Yet, only 11 days later, the CRA made the settlement offer in which it asks Ludmer to agree to be reassessed as set out in the letter, except for the gross negligence penalties.

[661]    The Plaintiffs argue that the fact that the CRA offered to abandon the gross negligence penalties only 11 days after asking for them shows that the gross negligence penalties are not serious. The Court does not agree. Penalties are not tax. The “no more and no less” notion does not apply. They are discretionary. The CRA must act reasonably in imposing penalties, but it can negotiate a settlement in which it waives those penalties.

[662]    In this matter, the Court has already concluded that there was a reasonable basis for imposing penalties. Moreover, the underlying assessment relating to Sandringham was reasonable. As such, the CRA could threaten to assess penalties relating to Sandringham and could offer to waive them if the Plaintiffs agreed to pay the Sandringham assessment. This is also a mitigating factor with respect to the attempt to extract concessions in exchange for abandoning the SLT position: the CRA was attempting to obtain payment of the Sandringham assessment, which was not unreasonable. It is not a case where the CRA was attempting to extract an unreasonable concession.

[663]    Finally, the apparent relationship between the settlement offer and the obligation to respond to follow-up questions in the discovery process in the Tax Court cases is also problematic.

[664]    The CRA was obliged to produce its responses to certain follow-up questions on May 30, 2014. In particular, pursuant to Undertaking 37, the CRA was required to confirm whether it accepted the conclusions in the Sixth TI dated April 8, 2011 with respect to the interpretation of the proposed FIE and CIF rules.[441] The Plaintiffs argue that this question put the CRA in a very awkward position because, they suggest, the CRA had already determined that it had no principled basis on which deny the application of the CIF rules to the SLT Plaintiffs but the CRA did not want to admit it.

[665]    Three days before that deadline, the CRA made the settlement offer. There was no delay for accepting the offer, but there was a condition that the Plaintiffs had to agree to suspend all litigation within three days. This delay does not appear to be coincidental. It appears that the settlement offer was made for the purpose of avoiding the obligation to respond to the follow-up questions.

[666]    This conclusion is further supported by subsequent events. When Ludmer did not agree within three days to suspend the litigation, the CRA made a motion on May 30 to suspend the timetable order.

[667]    The Court does not, however, agree with the Plaintiffs that the CRA was seeking to terminate only the two Tax Court appeals while keeping alive all of the other years for all of the other Plaintiffs. That does not appear to have been the CRA’s intent. It offered to terminate only the two Tax Court appeals because those were the only two appeals that were active at that time. The Court accepts that the intention was to give up all reassessments for all taxpayers for years prior to March 5, 2010. No one intended to restart the process for other taxpayers and other years. The Plaintiffs’ suspicions in that regard are not well founded, but they are understandable given the way this matter had progressed over the previous five years.

7.3   Conclusion

[668]    The CRA did not act properly in regard to the settlement offer in May 2014. It offered to settle the SLT reassessments that it knew it was going to abandon. In those circumstances, it should have abandoned those reassessments unilaterally rather than try to obtain concessions in exchange for abandoning them. The Court recognizes that the CRA could negotiate with respect to the Sandringham penalties. The reasonableness of the Sandringham assessments is a mitigating factor.

[669]    However, the situation is aggravated by the fact that the settlement offer was timed to avoid the obligation to file responses to follow-up questions. This is not a proper reason for settling a tax claim.

[670]    The Court does not, however, conclude that the Sandringham proposal is unreasonable merely because it was filed quickly to form part of the settlement offer.

8.    Access to information requests

8.1   Background

[671]    The purpose of the ATIA is set out as follows:

2 (1) The purpose of this Act is to extend the present laws of Canada to provide a right of access to information in records under the control of a government institution in accordance with the principles that government information should be available to the public, that necessary exceptions to the right of access should be limited and specific and that decisions on the disclosure of government information should be reviewed independently of government.

[672]    The ATIA is quasi-constitutional in nature, highlighting its important purpose.[442]

[673]    Pursuant to the principles set out in Section 2, the ATIA includes a number of provisions that are important in the context of the present litigation:

·                    Every Canadian citizen and permanent resident has a right to be given access to any record under the control of a government institution (Section 4(1) ATIA);

·                    Every government institution has the duty to assist the requester (Section 4(2.1) ATIA);

·                    If the requester is entitled to access, the government institution must give access within 30 days of the request (Section 7 ATIA), unless the institution extends the time limit for a reasonable period of time because of the large number of records or the need for consultations (Section 9(1) ATIA);

·                    The government institution may refuse to give access to a record in certain defined circumstances (Sections 13 to 24 and 26 ATIA);

·                    The Information Commissioner receives and investigates complaints (Section 30(1) ATIA), but only has the power to issue a report with her findings and recommendations (Section 37 ATIA);

·                    There is a possibility of review by the Federal Court after the Commissioner issues her report (Section 41 ATIA). The Federal Court can order disclosure in an appropriate case (Sections 49 and 50 ATIA).

[674]    The CRA is listed in Schedule 1 of the ATIA as a government institution to which the ATIA applies.

[675]    The ATIP Directorate within the Public Affairs Branch at CRA headquarters supports the CRA in meeting its requirements under both the ATIA and the Privacy Act.

[676]    Initially, Vallée was the ATIP person in charge of preparing the CRA’s responses to the ATIA requests made by Ludmer. After Vallée’s retirement in 2011, Fidanza took over.

8.2   Requests in the present matter

[677]    In the early stages of the audit, on August 19, 2009, seven Ludmer companies made requests to the CRA for documents under the ATIA.[443]

[678]    Essentially, they requested access to their audit file and to the SLT audit file.

[679]    In principle, the CRA had 30 days to provide the responsive documents. Instead, on September 22, 2009 (beyond the 30 day delay), the CRA extended the time delay to answer by 120 days.[444]

[680]    Oslers explained that it was crucial that it receive the documents because it needed the documents to respond to the Montreal TSO, which had proposed a reassessment and was threatening to charge penalties based on its conclusion that SLT was a controlled foreign affiliate of 3421848, 2534-2825 and 4077211.[445] The Montreal TSO had provided only redacted versions of the documents on which it based its conclusion.

[681]    The Plaintiffs did not receive the responsive documents until January 28, 2010, more than five months after the initial request.

[682]    The Plaintiffs considered that the response was inadequate and filed a complaint to the Information Commissioner on February 18, 2010.[446] The report of the Commissioner was only received on May 1, 2012, more than two years later.[447] The CRA had produced additional records on March 1, 2012, and the Commissioner concluded that the complaint was “well-founded” but “resolved”. The Plaintiffs were not satisfied with the report and made an application for judicial review to the Federal Court on June 8, 2012.[448] They abandoned the application with the release of the master file after the issuance of the final reassessments in May 2012.

[683]    The Plaintiffs ultimately updated the request five times to cover additional time periods,[449] and they made further requests for the documents surrounding the request to the authorities in Bermuda[450] and with respect to the records that they discovered were missing.[451] They also made requests with respect to ATIP itself.[452]

[684]    This same pattern was repeated with respect to each ATIA request. It is not necessary to go through everything that happened with respect to each of the ATIA requests. The Court includes as Appendix 2 a summary of the ATIA requests based on a table prepared by the Defendants.[453] The pattern is as follows:

·        The Plaintiffs made requests for documents;

·        The CRA gave itself an extension to the 30-day period provided by law;

·        The CRA eventually responded with a series of highly redacted documents, each time confirming that all responsive documents had now been disclosed;

·        The Plaintiffs were dissatisfied with each response and made a number of complaints to the Information Commissioner. The Information Commissioner concluded that the complaints were well-founded but resolved. In any event, the Information Commissioner did not have the power to compel the CRA to do anything;

·        Once the Plaintiffs had the Information Commissioner’s report, they would seek judicial review in the Federal Court;

·        Once they had exhausted their recourses, the Plaintiffs would make a new request and the process would repeat itself.

[685]    In addition to the very lengthy delays in responding,[454] the evidence makes clear that there were numerous mistakes and poor decisions made by the CRA in relation to the ATIA requests.

[686]    One such issue is the “missing records” issue:

·        When the initial request was received, ATIP identified only the Montreal TSO as a potential source of documents even though it must have been clear to everyone involved in the audit that many other branches of the CRA were involved in the matter;

·        The Plaintiffs complained in August 2013 that the responses to the ATIP requests did not appear to include files or documents from individuals in the ATP Division, Rulings or the Competent Authority.[455] It was only at that time that Fidanza tasked the other branches to produce documents. Additional records were produced;

·        In that process, Fidanza was informed that Adams and Jolie had retired and that their e-mail boxes had been destroyed;[456]

·        The CRA nevertheless responded in January 2014 with 8,704 records and the statement that all responsive records had been disclosed.[457] The Plaintiffs were not informed that any records had been destroyed;

·        The Plaintiffs, still not satisfied, prepared a list of CRA officials whose records still appeared to be missing, including Adams, Jolie and Ranger, who had also retired;[458]

·        The CRA found a further 10,815 records by April 30, 2014;[459]

·        Fidanza made further inquiries as to the status of the deleted e-mailboxes of the three officials. The conclusion was that those individuals had retired without having been asked to gather the relevant documents in their possession, and their e-mail boxes were destroyed within 60 days of their retirement, without any backup having been created;

·        Further, Fidanza discovered that Leduc’s e-mailbox had also been destroyed on his retirement. Leduc had been specifically tasked with the ATIP request and therefore his documents should have been produced prior to his retirement. However, when his e-mails prior to December 2009 were found to be available as a result of an inquiry by the Internal Affairs department, a further 2,063 pages were found in that partial e-mailbox.[460]

[687]    This is troubling at many levels.

[688]    The CRA’s initial failure to task anyone beyond the Montreal TSO is incomprehensible. Everyone involved in the audit knew that others were involved. For Vallée or Fidanza, who were not involved in the audit, even a cursory review of the documents produced by the Montreal TSO would show the involvement of others.

[689]    Further, the CRA’s document production system does not attach sufficient importance to e-mailboxes. It seems to be built on the assumption that e-mailboxes are transient in nature and therefore are not being used to store documents. Anyone who has an e-mailbox knows that this is not true.[461]

[690]    Finally, the CRA allows the destruction of e-mailboxes when an employee retires without archiving the contents and without verifying whether they contain records responsive to pending access requests.

[691]    In the face of all of these issues, the CRA confirmed over and over that its disclosures were complete when they clearly could not be.

[692]    The second issue are the exemptions to the obligation to produce. The ATIA provides that “necessary exceptions to the right of access should be limited and specific”. From the outset, the CRA interpreted the exemptions very broadly. It made very broad claims of injury to the audit, disclosure of investigative techniques, third party information, information from foreign governments, discussions between government departments, and solicitor-client privilege to justify the non-disclosure of documents or the heavy redaction of documents. This resulted in the non-disclosure or redaction of a series of key documents.[462]

[693]    One particularly egregious example is the 18,000-page “master file”, which had apparently been created to gather all information on SLT that would be common to the various taxpayer audits. The CRA took the position that the entire master file was exempt from disclosure under Section 16(1)(c) ATIA because of the potential prejudice:

Failure to apply the sections mentioned above will bear dire consequences for the CRA in terms of loss revenues and making available a structure for offshore funds that should the CRA be unable to assess, giving these potential Canadian investors an undue tax advantage.[463]

[694]    This passage suggests that the CRA’s concerns are that it will be more likely to lose if it discloses the information and that there are very large amounts at issue. Those are not proper bases for claiming the exemption.[464] Moreover, by providing a single blanket exemption for the whole master file instead of reviewing the master file page by page and claiming the appropriate exemption for each page or part of each page, the CRA did not provide any information to the Plaintiffs and did not even disclose to the Plaintiffs the existence of the master file.

[695]    By the time of the trial in the present matter, the CRA had produced unredacted versions of virtually all of the documents, but disclosure had been delayed for years in some instances. The unreasonable scope of the exemptions is obvious from even a cursory review of the formerly redacted documents.

[696]    Moreover, there was a failure to assist. The CRA did not even number the pages in the master file until May 2011, almost two years after the initial access request, which had the effect of substantially slowing the work of the Commissioner when it commenced the page by page review that the CRA had not done. Slowing the work of the Commissioner had the effect of delaying disclosure even longer.

[697]    When Adams was informed in July 2011 of Federal Court proceedings relating to an ATIA request in this file, he wrote to Gibson:

Lynda, I was speaking with the Justice lawyer who will be appearing in court on Monday responding to Oslers writ of mandamus filed against the Information Commissioner to compel the production of information. Whether that succeeds or doesn’t succeed, I see that writ as one of several sequential legal motions to be put before the court, combined with a petition to the Ombudsman to commence an investigation.  After a while, I think that someone is going to question why we are exhausting our resources resisting the release of documentation the taxpayer is largely entitled to have access to.

241(4)(b) makes it pretty clear the Minister can and should release information relevant to the reassessment.  In this case, information related to the determination of controlled foreign affiliate status falls within these provisions. If our position is that 241(4)(b) is a discretionary position, and on behalf of the Commissioner, we are choosing not to release the information, we may want to let people know so they are not surprised if and when legal proceedings commence. I confess to some surprise that we have put the Information Commissioner in a situation where she has to defend our actions, when her counsel may not fully understand our actions, but will, nonetheless, petition the Court to dismiss Oslers writ. I would have thought that we might want to be cooperative at least by providing some documentation we know the taxpayer is entitled to, just to release some of the emotional tension surrounding this file.[465]

[Emphasis added]

[698]    This email did not trigger any increased disclosure. Ironically, even this email was redacted under Section 21(1)(b) ATIA as “an account of consultations or deliberations in which directors, officers or employees of a government institution, a minister of the Crown or the staff of a minister participate”.

[699]    It is clear that the CRA was at fault in the ATIA process.

[700]    The effect of all of these errors and poor decisions was to delay the inevitable disclosure of the relevant documents by years and to put the Plaintiffs to tremendous expense in the process.

[701]    Moreover, documents were destroyed. It is impossible to know exactly what was destroyed. It is perhaps a less serious issue in the context of this case, in that only a few e-mailboxes were destroyed and copies of the destroyed documents were found in other e-mailboxes and included in the record. Moreover, each of Adams, Jolie, Ranger and Leduc testified at the trial. There is no evidence that any destroyed document would have had an impact on the outcome of this litigation.

9.    Conclusion on Fault

[702]    The Court concludes that the CRA was at fault in its conduct of the SLT audit:

·        The CRA took an unreasonable final assessing position on the following issues:

• Its interpretation of Regulation 7000 was inconsistent with its prior (and subsequent) position with respect to similar instruments issued by financial institutions in Canada;
• Its interpretation of Regulation 7000 to include the increase in value of the Notes in taxation years prior to 2005 was unreasonable;
• Its position denying the application of the CIF rules was inconsistent with the clear evidence; and
• Its calculation of foreign exchange was inconsistent with the position of Rulings and resulted in a much higher amount of income from year to year;

·        It failed to give the five days’ notice prior to issuing the reassessments in May 2012, as promised in November 2010. It also filed to provide the responsive submissions, as promised in June 2011;

·        In making a request for information from the Bermudian authorities, it characterized the SLT matter as “a criminal tax matter”;

·        It acted improperly in regard to the settlement offer in May 2014 by offering to settle elements that it knew it was going to abandon;

·        It was at fault in the ATIA process and thereby delayed the inevitable disclosure of the relevant documents by years and put the Plaintiffs to considerable expense.

[703]    The Plaintiffs sought to characterize these faults as deliberate, in order either to get Ludmer or to destroy SLT or as an attempt to collect greater bonuses.

[704]    The Court rejects both arguments.

[705]    With respect to the personal animus against Ludmer, the theory appeared to be that the CRA was mad at Ludmer because he had beaten them in a tax dispute that went all the way to the Supreme Court of Canada in 2001.[466] The Plaintiffs put questions to each CRA witness as to whether they were aware of the prior litigation and whether they bore any grudge against Ludmer as a result of it. Most witnesses testified that were not aware of the prior litigation, and those that were aware of it testified that it did not affect their attitude towards Ludmer in the SLT audit. The testimonies appear credible and the Court has no basis to reject them other than speculation by the Plaintiffs. The Court dismisses this argument.

[706]    As for the attempt to destroy SLT to dissuade Canadians from investing in similar vehicles going forward, the Plaintiffs point to the so-called Stephkan settlement, which was conditional on the taxpayer selling its SLT shares and thereby crystallizing the deferred capital gain,[467] Adams’ recommendation that the CRA consider a settlement “where the investment would be wound up”,[468] and the CRA request for information from the Irish authorities,[469] which the Plaintiffs characterize as a transparent attempt to cause SLT to be de-listed.[470]

[707]    With respect to Stephkan, the settlement was signed by a CRA official under peculiar circumstances at the time of or possibly after his retirement. The CRA did not wish to continue with the settlement, and it was the taxpayer who sued to homologate it. This is hardly evidence of an attempt by the CRA to harm SLT through the settlement.

[708]    Similarly, the Adams settlement idea was floated within the CRA at the time of Adams’s retirement and Ranger rejected it.[471]

[709]    Finally, with respect to the request to Ireland, the Plaintiffs plead that “[i]t is evident that what the CRA was actually looking for, with the Irish request, was the de-listing of SLT from the Irish stock market”,[472] but that “[t]his transparent attempt by the CRA was well understood, and rebuffed, by the Irish authorities.”[473] There is no evidence to support either assertion. The CRA made a request and the Irish authorities answered. The request was made to verify whether the SLT shares were “listed on a designated stock exchange”, such that the charitable donations of SLT shares by the Ludmer Plaintiffs in 2010 and 2011[474] qualified for zero capital gains treatment under Section 38(a.1) ITA. It was a legitimate request. There is no evidence that it was anything else.

[710]     As a result, there is no evidence of an attempt by the CRA to put SLT out of business.

[711]    Finally, the evidence with respect to bonuses was not convincing. There was some evidence that the Montreal TSO would receive some TEBA numbers based on assessments issued and that the TEBA numbers had some relevance in bonuses,[475] but the evidence was insufficient to establish that the CRA officials involved in the SLT audit had a personal motive to assess for a high amount or that anyone acted pursuant to that personal motive. The Court dismisses this argument as well.

C.   REMEDIES

[712]    The Plaintiffs claim the following remedies:

1.	Lost interest on amounts paid pursuant to the reassessments	$4,455,588.24
2.	Professional fees	$16,441,919.66
3.	Compensatory damages to Ludmer and Steinberg’s estate for reputational loss, stress, trouble and inconvenience	$9,000,000.00
4.	Compensatory damages to 4431472 and 4431481 for loss of future income	$38,515,000.00
5.	Refund of tax paid by 4431472 and 4431481	$9,092,323.00
6.	Punitive damages	$40,000,000.00
	TOTAL	$117,504,830.92

[713]    In addition, the Plaintiffs ask the Court to order a stay of the proposed reassessments relating to the Sandringham audit, or to issue one of three subsidiary declarations with respect to those reassessments.

1.    Lost interest on amounts paid pursuant to the reassessments

[714]    The various SLT Plaintiffs paid almost $40,000,000 to the Receiver General of Canada, the Ministre du revenu du Québec and the Government of Alberta pursuant to the reassessments issued during the audit.[476] The amounts paid were all reimbursed starting in January 2015, with interest at 1%.[477]

[715]    The Plaintiffs claim the difference between the interest that was paid and interest at the legal rate and the additional indemnity provided for in Article 1619 C.C.Q. The Plaintiffs calculate the total to be $4,455,588.24. The allocation of those amounts is set out in the conclusions of the Re-Re-Amended and Re-Particularized Motion to Institute Proceedings.

[716]    The starting point is whether the payments by the Plaintiffs were mandatory or voluntary.

[717]    Under Section 225.1 ITA, the CRA can commence collection proceedings 90 days after it sends a notice of assessment.

[718]    Collection proceedings are stayed by a notice of objection or an appeal to the Tax Court. If the taxpayer serves a notice of objection to the assessment, the CRA’s right to commence collection proceedings is stayed until 90 days after the CRA has confirmed or varied the assessment. If the taxpayer appeals to the Tax Court, the CRA’s right to commence collection proceedings is stayed until 90 days after the Tax Court mails a copy of its decision or the taxpayer discontinues the appeal.

[719]    However, the stay is only partial where the taxpayer is a “large corporation”. In that case, the CRA has the right to collect one-half of the amount assessed notwithstanding any notice of objection or appeal.

[720]    Under Section 225.1(8) ITA, a corporation is a “large corporation” if the total of the taxable capital employed in Canada of the corporation and its related parties exceeds $10 million.

[721]    The SLT Plaintiffs who received notices of assessment were all corporations. The notices of assessment sent to the Ludmer SLT Plaintiffs identify the Ludmer SLT Plaintiffs as large corporations and remind them of their obligation to pay one-half of the amount assessed immediately.[478] The Steinberg SLT Plaintiffs were not identified as large corporations in their notices of assessment,[479] and there is no evidence that they had any obligation to pay 50% of the amount assessed.

[722]    As a result, one-half of the payments by the Ludmer SLT Plaintiffs were mandatory and the other one-half were voluntary. All of the payments by the Steinberg SLT Plaintiffs were voluntary.

[723]    There is an incentive to make voluntary payments. Any unpaid amounts which are ultimately found to be due are payable with interest compounded daily from the date that the tax was payable. Between 2009 and today, the rate has been 5%, except for two quarters when it was 6%.[480] Any amounts which are paid and are ultimately found not to be due are reimbursed with interest. These rates have been 1% (corporations) and 3% (non-corporations) throughout the period since 2009, except for two quarters where they were 2% and 4% respectively.

[724]    As a result, a taxpayer who is challenging an assessment must make a choice: if he makes a voluntary payment, he reduces the interest that he will be required to pay if the assessment is maintained, but he gets very little interest on the refund if the assessment is set aside; on the other hand, if he does not make the voluntary payment, he runs the risk of paying substantial interest if the assessment is maintained.

[725]    Ludmer explained that he made these voluntary payments in order to avoid having to pay 5% interest on late payments.[481] However, he had to know that he would only be paid 1% interest on the amounts refunded.

[726]    The Court will allow the claim with respect to the interest on the mandatory payments. The Plaintiffs should not have been required to pay those amounts. The Court accepts the calculation by the Plaintiffs, namely interest at the legal rate plus the additional indemnity, less the 1% interest paid on refunds. Further, the Court will include the lost interest on the mandatory payments to the Québec and Alberta tax authorities. The Court is satisfied that the provincial tax authorities were simply following the CRA’s lead, such that there is a causal link between the CRA’s faults and the provincial reassessments and payments.

[727]    However, the Court is not satisfied that the SLT Plaintiffs are entitled to recover the lost interest on the voluntary payments. They plead in very strong language that the position taken by the CRA on the reassessments was unreasonable. In those circumstances, there was no reason for the SLT Plaintiffs to make a voluntary payment, because there was no risk that they would be ordered to pay the reassessments. The Court will dismiss the claim for lost interest on the voluntary payments.

[728]    As a result of all of the foregoing, the Court will dismiss the claims by the Steinberg SLT  Plaintiffs and will maintain the claims by the Ludmer SLT Plaintiffs for one-half of the amounts claimed:

Ludmer SLT Plaintiff	Amount claimed	Damages
2534-2825	$2,061,342.99	$1,030,671.50
3488055	$61,809.51	$30,904.75
3488063	$63,090.08	$31,545.04
3488071	$60,496.85	$30,248.43
4077211	$747,706.95	$373,853.47
TOTAL	$2,994,446.38	$1,497,223.19

 

2.    Professional fees incurred

[729]    The Plaintiffs argue that the CRA knew or should have known by July 2007 at the latest that the SLT audit was doomed to failure. For that reason, they claim as damages all professional fees incurred in connection with the audit and in all of the related proceedings in Tax Court, before the Information Commissioner and in Federal Court from the beginning of the audit in 2009 until the trial in 2016. The total amount claimed is $16,441,919.66 and it is divided as follows among the various Plaintiffs and the various professional firms:[482]

 

Plaintiff	Oslers	Richter	Fraser/ Dentons	Ogilvy/  Norton	Heenan Blaikie	Tom Zacchia	Joel Shafer	Bessner/ Crowe	Total
2534-2825	5,167,689.78	297,148.56	118,253.40	57,128.19	8,453.46	4,500.00	17,817.73	0.00	5,670,991.12
4077211	1,538,529.46	28,104.22	9,500.16	0.00	0.00	1,500.00	0.00	0.00	1,577,633.84
3488071	388,043.46	0.00	2,375.04	0.00	0.00	1,700.00	0.00	0.00	392,118.50
3488063	388,778.12	0.00	2,375.04	0.00	0.00	1,700.00	17,817.72	0.00	410,670.88
3488055	388,224.23	0.00	2,375.04	0.00	0.00	1,700.00	0.00	0.00	392,299.27
3421848	3,168,574.70	771.75	0.00	0.00	0.00	0.00	0.00	0.00	3,169,346.45
Habland	624,028.36	926.10	0.00	0.00	0.00	0.00	0.00	8,662.00	633,616.46
Stoneview	3,727,618.11	230,907.61	134,878.68	53,622.74	0.00	0.00	33,279.00	14,937.00	4,195,243.14
	15,391,486.22	557,858.24	269,757.36	110,750.93	8,453.46	11,100.00	68,914.45	23,599.00	16,441,919.66

 

[730]    With respect to the recovery of professional fees, the Québec Court of Appeal established in Viel that a litigant cannot recover as damages the fees paid to his or her attorney for conducting litigation even if the litigation is successful and is in response to a fault or abusive conduct by the other party. Legal fees for conducting litigation are recoverable as damages only where the conduct of the other party during the litigation amounted to an abuse of process. The distinction is between “abuse on the merits” and “abuse of process”:

76.        Je formule la question qui nous est posée comme suit : la conduite répréhensible, abusive et de mauvaise foi d'une partie sur le fond du litige permet-elle en soi à la partie adverse de réclamer les honoraires extrajudiciaires de son avocat à titre de dommages-intérêts ?

77.        Soit dit avec égards, les principes de la responsabilité civile m'incitent à apporter une réponse négative à la question posée. En principe et sauf circonstances exceptionnelles, les honoraires payés par une partie à son avocat ne peuvent, à mon avis, être considérés comme un dommage direct qui sanctionne un abus sur le fond. Il n'existe pas de lien de causalité adéquat entre la faute (abus sur le fond) et le dommage. La causalité adéquate correspond à ou aux événements ayant un rapport logique, direct et immédiat avec l'origine du préjudice subi. Seul l'abus du droit d'ester en justice peut être sanctionné par l'octroi de tels dommages. Il m'apparaît erroné de transformer l'abus sur le fond en un abus du droit d'ester en justice dès qu'un recours judiciaire est entrepris. Quelques explications s'imposent.

78.        Il est acquis au débat qu'une partie ne peut, règle générale, être compensée des honoraires payés à son avocat pour faire valoir ses droits. Le justiciable devra payer ces honoraires extrajudiciaires qu'il y ait ou non abus sur le fond. Les honoraires ne seraient d'ailleurs pas encourus si la partie adverse reconnaissait, dès le début des procédures judiciaires, sa faute même si cette dernière peut être qualifiée d'abus sur le fond (conduite abusive, répréhensible, scandaleuse, outrageante, de mauvaise foi). Dans ce cas, malgré la conduite abusive sur le fond, la partie n'aurait pas à débourser inutilement des honoraires à son avocat. Cet exemple démontre l'absence de lien de causalité suffisant entre la faute et le dommage.

79.        À l'inverse, peu importe qu'il y ait abus ou non sur le fond, une partie qui abuse de son droit d'ester en justice causera un dommage à la partie adverse qui, pour combattre cet abus paie inutilement des honoraires judiciaires à son avocat. Il y a, dans ce cas, un véritable lien de causalité entre la faute et le dommage.[483]

[Emphasis added]

[731]    In its written argument, the CRA cites paragraph 145 of the Supreme Court judgment in Hinse. The Court adds paragraph 144 not cited by the CRA:

[144]     Poulin J. ordered the AGC to pay Mr. Hinse $193,660.88 under the head of claim for fees and costs incurred in respect of the proceedings he brought in the Court of Appeal and the Supreme Court between 1990 and 1997. She was wrong to do so. Even if the Minister had granted one of Mr. Hinse’s applications, he would have either ordered a new trial or referred the matter to the Court of Appeal. In short, Mr. Hinse would have had to pay these fees anyway. This is not damage that resulted from the alleged faults.

[145]     Poulin J. awarded $500,000 for investigation costs, wasted time and effort, photocopies, transcripts, travel, postage, etc. The Court of Appeal correctly found that wasted time and efforts expended to obtain justice are inconveniences that are inherent in the efforts of anyone who is involved in legal proceedings: para. 215. Unless there has been an abuse of process, these are not heads of damage under which Mr. Hinse can seek compensation. Moreover, they fall under non-pecuniary damage, given that there is no evidence of lost income. Since Poulin J. awarded a separate amount in respect of non-pecuniary damage, this resulted in double recovery.[484]

[Emphasis added]

[732]    Reading the two judgments together, the Court considers the law to be as follows:

·        The professional fees, as well as investigation costs, wasted time and effort, photocopies, transcripts, travel, postage, etc., incurred in litigation or in preparing for litigation are not generally recoverable. They are considered not to be caused by the defendant’s fault that gave rise to the litigation but to be inconveniences inherent in litigation. They are only recoverable if the litigation is an abuse of process or there has been an abuse of process in the litigation;

·        However, the professional fees and other costs incurred before the litigation and not in preparation for the litigation are recoverable to the extent that there is a sufficient causal link with the defendant’s fault. To establish that link, the plaintiff must demonstrate that he would not have incurred those fees and other costs but for the defendant’s fault. The link is not established if he would have been required to incur them in the absence of the fault.

[733]    The Plaintiffs are not claiming the fees of their attorneys in the present proceedings in Superior Court.

[734]    The Plaintiffs are claiming the professional fees that they incurred in connection with the audit and in all of the related proceedings in Tax Court, before the Information Commissioner and in Federal Court, because they would not have incurred these fees but for the faults of the CRA.

[735]    The Court agrees that the SLT Plaintiffs incurred professional fees that they should not have been required to incur and that they are entitled to be reimbursed those professional fees as damages in the present matter. However, they are not entitled to be reimbursed all of the professional fees that they are claiming.

[736]    The first issue is the professionals whose fees are being claimed. By far the largest portion of the claim relates to Oslers and Richter, whose involvement in the file is well documented. However, as set out in the table above, there are also amounts charged by other professionals:

·        Heenan Blaikie LLP

·        Ogilvy Renault LLP/Norton Rose OR LLP

·        Fraser Milner Casgrain LLP/Dentons Canada LLP

·        Tom Zacchia, Chartered Professional Accountant

·        Joel Shafer

·        Bessner Gallay Kreisman LLP

·        Crowe BGK

[737]    The role played and the services rendered by these other professionals were not fully explained at trial and do not appear from the invoices produced:

·        Heenan Blaikie was not mentioned at the trial or in the exhibits, and no Heenan Blaikie invoices were produced.

·        Ogilvy Renault/Norton Rose invoices were produced but the invoices do not explain its role. Me Wilfrid Lefebvre, a senior tax lawyer at Ogilvy Renault/Norton Rose, was mentioned during the trial and certain exhibits refer to him - he was authorized as a representative of Irving Ludmer on November 16, 2010,[485] he was present at a meeting with the CRA at Oslers on November 25, 2010,[486] and he was listed as co-counsel on the draft notices of application left with the CRA at the November 25, 2010 meeting,[487] and he had some discussions and meetings with Ranger in March and April 2012.[488] However, it is not clear why his involvement was thought to be necessary.

·        The Fraser Milner Casgrain/Dentons Canada invoices relate to services rendered by Bowman. His opinion in relation to Sandringham dated June 25, 2014 was produced,[489] but the claim does not relate to that opinion. He appears to have rendered services as early as 2011, but there is no explanation as to any other services he may have rendered.

·        Zacchia was one of Ludmer’s accountants. He was mentioned at trial[490] and he appears in the correspondence.[491]

·        Shafer was not mentioned at the trial and his name does not appear in any exhibit other than his invoices. His invoices refer to services rendered on the tax appeals, but one of his invoices is for a director’s fee.[492]

·        Bessner Gallay Kreisman/Crowe BGK was Steinberg’s personal accountant.[493]

[738]    The Court will exclude the claim for services rendered by Heenan Blaikie, Ogilvy Renault/Norton Rose, Fraser Milner Casgrain/Dentons Canada and Shafer, in the total amount of $457,876.20. It is not clear what services were being rendered or why those services were necessary, given Oslers’ presence throughout the file.

[739]    The remaining invoices cover the period from 2009 to 2016. It is difficult to see on what basis fees incurred after October 6, 2014 at the latest[494] can be said to have been incurred in relation to the audit. After that date, there are only three tax appeals outstanding in the total amount of approximately $225,000.[495] Yet the professional fees claimed for the period after that date total approximately $4.1 million.[496] These fees must relate to the current litigation and not to the remaining tax appeals. They will be excluded.

[740]    Further, the Court will exclude the professional fees incurred in 2009 and 2010. As mentioned above, the CRA was entitled to review carefully the SLT structure and Ludmer and Steinberg’s positions in SLT. The process really goes off the rails in 2011 with the Sixth TI that is not followed and the doubts expressed by Adams, Jolie and others.

[741]    Further, not all of the services rendered by Oslers, Richter, Zacchia and Bessner between 2011 and 2014 relate to the SLT audit.

[742]    The Court recognizes that the Plaintiffs have attempted an allocation exercise with respect to the Richter, Zacchia and Bessner invoices in that only a portion of each invoice is claimed. For example, the Zacchia invoices refer to the preparation of financial statements and tax returns, but only a small portion of these invoices was included in the claim. It is similar for Bessner. A larger portion of the Richter invoices is claimed. The Court does not have the detail as to how that allocation exercise was carried out.

[743]    Further, it appears that Oslers had more than one file open for each client and allocated its time between the different files. Most of the invoices received by 2534-2825 are in file F#1115528 (St. Lawrence Trading Inc.). However, 2534-2825 received an invoice from Oslers dated May 31, 2009 in file 1114580 (Voluntary Disclosure). Later, 2534-2825 received two invoices from Oslers for the period May 1, 2016 to August 30, 2016, one in file F#1115528 (St. Lawrence Trading Inc.) and one in file F#1174703 (Ludmer et al. v. CRA).[497] Again, the Court has no detail as to how many other files exist, when each one was created and how the allocation of time was carried out, but it is clear that the invoices in files 1114580 and 1174703 are not recoverable in this litigation - the CRA committed no fault in the voluntary disclosure file and the SLT Plaintiffs cannot recover fees incurred in relation to this litigation.[498] It is likely that Oslers had other files, such as Sandringham, and that the Plaintiffs are not claiming the fees incurred in those files. Again, however, it is not clear if those other files exist, when they were opened and whether some charges relating to those other files are included in the claim.

[744]    Finally, not all of the work done by Oslers or the accountants in relation to the SLT audit between 2011 and 2014 is recoverable. Work done with respect to the voluntary disclosure is not recoverable. The SLT Plaintiffs would have been required to incur some professional fees in dealing with the SLT audits and in convincing the CRA not to assess them in relation to their investments in SLT. They would have incurred some professional fees in making the ATIA requests. However, the professional fees actually incurred are much higher than they should have been by reason of the CRA’s insistence on maintaining positions that were not consistent with their earlier positions in other matters, the CRA’s failure to apply the CIF rules in a reasonable fashion, the CRA’s negligent dealings with the taxation authorities in Bermuda and the CRA’s failure to deal with the ATIA requests promptly and reasonably.

[745]    One final aspect is the amount of the Oslers fees. The Court has no comment on the quality of the lawyering by Oslers. It accepts that all of their work was done to the highest standard. However, the Court does have a concern about the quantity of lawyering. Oslers filed detailed and voluminous submissions on every issue. The submissions often repeated what had been filed previously on the same issue. The overall effect, as described by Gibson, is that “Rulings have never been so bombarded”.[499]

[746]    The Court does not question the merit or the effectiveness of that approach. It is clear that a very wealthy taxpayer can bombard the CRA with submissions. However, that does not mean that the taxpayer can recover all of the professional fees incurred from the CRA. There is a principle of proportionality applicable in this context. The total amount claimed for the services rendered by Oslers between January 2011 and October 2014, a period of three years and nine months, is approximately $9 million or $2.5 million per year. That represents one lawyer at a very generous $1,000 per hour working more than full time at 2,500 hours per year continuously for the whole period. The Court considers that to be excessive.

[747]    While it is difficult to calculate with any degree of accuracy which portion of the professional fees would have been incurred in any event and which was caused by the faults of the CRA, and which portion of the professional fees represents excessive work done by Oslers, the Court estimates that it would be fair to award the Plaintiffs one third of the professional fees claimed, after the deductions set out above.

[748]    The Court will therefore award $3,097,435.66 damages to the SLT Plaintiffs, to be apportioned among them pro rata to the invoices produced:

 

	Osler	Richter	Tom Zacchia	Bessner/ Crowe	Total Claimed in Period	Total Awarded
3488055	227,087.05	0.00	0.00	0.00	227,087.05	75,695.68
3488063	226,980.10	0.00	0.00	0.00	226,980.10	75,660.03
3488071	226,963.59	0.00	0.00	0.00	226,963.59	75,654.53
2534-2825	2,962,757.80	142,321.05	2,333.05	0.00	3,107,411.91	1,035,803.97
4077211	905,939.76	0.00	926.06	0.00	906,865.82	302,288.61
Habland	434,457.24	0.00	0.00	4,177.34	438,634.58	146,211.53
Stoneview	2,077,928.71	155,307.20	0.00	9,795.96	2,243,031.86	747,677.29
3421848	1,914,560.32	771.75	0.00	0.00	1,915,332.07	638,444.02
	8,976,674.57	298,400.00	3,259.11	13,973.30	9,292,306.98	3,097,435.66

 

 

3.    Reputational loss, stress, trouble and inconvenience

[749]    Each of Ludmer and Steinberg’s estate claims $1,000,000 for reputational loss. Further, Ludmer claims $6,000,000 and Steinberg’s estate claims $1,000,000 for stress, trouble and inconvenience.

[750]    The reputational loss is based on the erroneous statement to the Bermudan tax authorities that there was a criminal tax matter involving SLT.

[751]    The original request to the Bermudan authorities[500] provides that the person under examination or investigation is:

3488063 Canada Inc-St. Lawrence Trading Inc. (SLT)

Company controlled by Mr. Irving Ludmer

 Canadian resident

[752]    It further provides, “We are investigating the shareholders of St. Lawrence Trading Inc, (SLT) resident of the British Virgin Islands.”

[753]    Steinberg is not named in the request, although he is directly and indirectly a shareholder of SLT.

[754]    When Rochefort added the erroneous clarification that it was a criminal matter, he added that “the Canadian taxpayers are under investigation.”[501]

[755]    The Bermudan authorities then prepared a Notice to Deliver-Up information dated September 27, 2012 which was sent to Harbour Fiduciary Services.[502] The Notice specifies that the Bermudan authorities received a request from the CRA “in respect of a criminal tax matter” and added that the CRA “is investigating the shareholders of St. Lawrence Trading Inc. (SLT)resident of the British Virgin Islands.” The Notice does not name Ludmer or Steinberg.

[756]    Harbour Fiduciary Services then forwarded the Notice to SLT, which in turn forwarded a copy to its shareholders.[503]

[757]    The statement that there is a criminal tax matter in relation to the shareholders of SLT is damaging to the reputation of the shareholders. Ludmer and Steinberg are the leading shareholders and they brought other family and friends into SLT, and therefore the statement is particularly damaging to them. Moreover, Ludmer is mentioned by name in the original request to the Bermudan authorities. 

[758]    The damage, however, is limited by the fact that the statement was not widely circulated and it was corrected promptly by the CRA when the error was brought to their attention The CRA withdrew the request on October 30, 2012,^[504] and apologized to the other SLT shareholders on November 22, 2012^[505] and to Ludmer on February 19, 2013.^[506]

[759]    Further, there was no proof of any specific losses such as lost contracts or shareholders exercising their puts. In the absence of proof of specific losses, the amounts awarded for damages to reputation in Canadian courts and in Québec courts in particular tend to be relatively small.

[760]    For the foregoing reasons, the Court awards Ludmer $100,000 and awards Steinberg $50,000.

[761]    Québec courts have not been generous with respect to stress, trouble and inconvenience either. They generally do not award damages for “inconveniences that are inherent in the efforts of anyone who is involved in legal proceedings”.[507] Most of what Ludmer and Steinberg complain about falls within this expression.

[762]    Two particular claims that Ludmer and Steinberg advance in this matter are that they had to pay the amounts assessed and they had to hire lawyers to fight the reassessments. Those matters are already covered elsewhere in this judgment: the Court has awarded damages for the lost interest on the mandatory payments and for the professional fees that were needlessly incurred.

[763]    Further, the Court will not award any damages at this stage with respect to the stress caused by the proposed Sandringham assessments, because the Court has concluded that they are not unreasonable.

[764]    It remains that Ludmer and Steinberg did suffer stress, trouble and inconvenience from having the SLT audits hanging over their heads for much longer than they should have. The Court will award them $50,000 each.

4.    Lost GAM payments

[765]    The Plaintiffs allege that the SLT audit and the harassment of the SLT shareholders by the CRA starting in May 2009 caused the SLT shareholders to put their SLT shares and move their investments elsewhere. The result of this move away from SLT is that the GAM payments for the benefit of 4431472 and 4431481 were reduced to nothing. The Plaintiffs estimate the present value of the lost GAM payments from 2009 to 2016 to be $38,515,000.

[766]    The Court has several difficulties with this claim.

[767]    First, there is the nature of the GAM payments.

[768]    As discussed above, these payments started with the merger of GAMCAN into GAM Multi-Global in 1995. GAMCAM had a lower fee structure than GAM Multi-Global, and one of the effects of the merger was that all of the shareholders would pay the higher GAM Multi-Global fees. An amount equal to the additional fees paid by the GAMCAN shareholders was remitted by GAM to Sandringham, a company controlled indirectly by Ludmer and Steinberg.

[769]    This arrangement was not clearly disclosed.

[770]    In the circular to the GAMCAN shareholders in November 1994, the directors of GAMCAN recommended that the shareholders approve the merger of GAMCAN into GAM Multi-Global, because of the similar investment policies and because the merger would allow participation in a more substantial company with a larger asset base that would have greater opportunity to access skilled investment managers and asset diversification.

[771]    The only mention of fees is as follows:

You should also note the section headed Fees and Expenses; the fees payable by Multi-Global for investment advice, sponsorship, management and administration exceed comparable running costs within Gamcan.

[772]    This is at best a very indirect disclosure of the fact that the fees payable by the GAMCAN shareholders will increase after the merger.

[773]    There is no disclosure of the fact that the increase in the fees paid by the GAMCAN shareholders will be remitted to Ludmer and Steinberg. The only mention of the GAM payments is the following:

If the Plan of Merger is approved and implemented, Mr. Arnold Steinberg and Mr. Irving Ludmer, until recently directors of Gamcan, will be invited by Global Asset Management Limited, London, the Investment Advisor of Multi-Global, to join an advisory committee in respect of Multi-Global. Companies in which they have an indirect interest will be paid a fee by a company within the GAM group.[508]

[774]    This suggests that a fee will be paid to a company indirectly controlled by Ludmer and Steinberg in exchange for their services on the advisory committee.

[775]    Further, on July 20, 1995, Sandringham signed an agreement with a GAM affiliate (GAM was substituted for its affiliate on November 10, 1995[509]) whereby GAM agreed to pay a fee to Sandringham “in consideration for investment consultancy services to be rendered by [Sandringham] pursuant to this Agreement”.[510] The agreement goes on to detail the services to be provided by Sandringham.

[776]    The Plaintiffs now take the position that Sandringham had no obligation to do anything and in fact did not do anything to earn the fees. They plead that the circular to the GAMCAN shareholders and the agreement between Sandringham and GAM do not accurately reflect reality. They do so because of the potential tax consequences of the agreement. They want to plead that the $104 million that Sandringham received from GAM is not income.

[777]    This creates a doubt as to the validity of the agreement between Sandringham and GAM. Its sole purpose is to disguise the fact that Ludmer and Steinberg were receiving the increased fees paid by their family and friends. It is a sham.

[778]    On top of that, the Plaintiffs ask the Court to award 4431472 and 4431481 $38,515,000 in damages, as the estimated present value of the GAM payments from 2009 to 2016 of which they were deprived.

[779]    The Court finds this offensive. The undisclosed payment to Ludmer and Steinberg of the increased fees paid by their family and friends is bad enough. The failure to disclose and the use of misleading documents whose sole purpose is to hide what was happening make it worse. That the Plaintiffs now renounce the documents because of their tax consequences completes the picture.

[780]    In these circumstances, the Court will not order the CRA to pay damages to replace these payments.

[781]    Further, there is a question of proof.

[782]    If the Court is wrong and it should award damages to 4431472 and 4431481 for the loss of the future payments from GAM, the Plaintiffs must make sufficient proof of the value of the lost future payments.

[783]    The future payments are dependent on the future value of the shareholdings held by the SLT shareholders (1) who were GAMCAN shareholders or were related to a GAMCAN shareholder at the time of the 1995 merger, (2) who were introduced to SLT by Sandringham, or (3) who are related to a shareholder in (1) or (2).

[784]    It will not be possible for the Plaintiffs to prove the future payments with certainly and the Court must not hold them to that standard. The Court is prepared to make reasonable assumptions as to the future value of SLT and the new investments and exercise of puts by SLT shareholders.

[785]    Both the Plaintiffs and the CRA produced expert witnesses who built models using what they considered to be reasonable assumptions.

[786]    Renata Milczarek of Mareval S.E.N.C.R.L. was the expert retained by the Plaintiffs. She filed a report dated December 11, 2014[511] and an updated report dated November 16, 2016.[512] She concluded in her updated report that the present value of the lost future payments was $38,515,000.

[787]    In her reports, Milczarek attempts to estimate the lost future payments following what Plaintiffs allege to be the abusive actions taken by the CRA starting in May 2009 that had the effect of driving off investors in SLT. To do this, she estimates what the future payments would have been without those actions. This involves two variables: the future value of the Reference Assets and the flow of new subscriptions and puts.

[788]    The future value of the Reference Assets is not a problem: Milczarek simply uses the actual rates of return of the Reference Assets.

[789]    The flow of new subscriptions and puts is more problematic. Milczarek uses as a proxy the net asset flows compiled by Hedge Fund Research, Inc. (“HFR”) for all funds of hedge funds.

[790]    She therefore starts with the actual value of the Reference Assets on July 1, 2009 and she estimates the value at the end of the quarter by applying these two factors:

·        She applies the net asset flow for the quarter for all funds of hedge funds to calculate the change in net assets that results from subscriptions and puts, and

·        She uses the actual rates of return of the Reference Assets for the quarter to calculate the change in net assets that results from the performance of the Reference Assets.

[791]      She then calculates the fee on the estimated value of the Reference Assets. The loss is equal to the difference between the actual payment and the estimated payment.

[792]    Adding the estimated losses for each quarter from July 1, 2009 to November 30, 2016, she comes to a total of $38,515,000.

[793]      Alain Viger of LBC International was the expert retained by the CRA. He filed a report dated January 27, 2016.[513]

[794]    He objects to Milczarek’s assumption that, but for the CRA’s conduct, the net inflow/outflow of investors in SLT would have mirrored the net inflow/outflow of investors in the hedge fund industry at large. His analysis is quite convincing.

[795]    First, he provides the following table of shares subscribed and sold in SLT from 2002 to September 2014:

	Number of shares Subscribed	Number of Shares Sold
2002	211,218.13	23,957.49
2003	92,401.19	5,614.86
2004	57,574.76	47,447.90
2005	22,763.88	40,093.95
2006	3,263.45	166,300.94
2007	-	332,131.06
2008	-	181,082.43
2009	-	84,721.66
2010	-	355,150.76
2011	-	449,667.15
2012	-	346,712.71
2013	-	178,042.30
2014 (up to September)	-	303,961.00

 

[796]    This table does not show a good picture. Focusing on the period before April 1, 2009 (Milczarek assumes that the abusive conduct started in May 2009), Viger emphasizes that SLT had no net inflow of funds since 2004 and no inflow whatsoever since 2006. The total number of shares sold between 2004 and 2008 exceeded the number of shares subscribed by almost 700,000. According to the figures in the Audit Report, the shares were worth approximately $700 each,[514]  such that the total outflow from 2004 to 2008 was approximately $500 million. This suggests that the continuing outflow after April 2009 may not be the result of anything that the CRA did, but may simply be the continuation of a pattern that began in 2004.

[797]    Further, the comparison of the net inflows/outflows for SLT and the hedge fund industry between January 2007 and March 2009 is telling:

	SLT	Industry	Difference
2007	(15.45 %)	9.03 %	(24.48 %)
2008	(8.21 %)	(6.24 %)	(1.97 %)
2009 (January to March)	(1.01 %)	(13.02 %)	12.01 %
TOTAL	(24.67 %)	(10.23 %)	(14.44 %)

[798]    Based on the ratio of the totals, Viger concludes that the outflow of funds from SLT is 2.41 times worse than the outflow from the hedge fund industry. He therefore applied that factor on a going forward basis to the industry-wide outflow of funds in any quarter where there was an industry-wide outflow. However, where there was a net inflow on an industry-wide basis, Viger ignores the funds which had experienced an inflow and applies the factor of 2.41 to the net outflows of funds of the hedge funds which had experienced a net outflow of funds during that quarter.

[799]    The Court rejects this analysis as inconsistent and mathematically unsound.

[800]    However, the figures show the complete lack of any correlation between the performance of SLT and the performance of the hedge fund industry in general with respect to the inflows and outflows of funds. In the three periods examined, 2007, 2008 and the first quarter of 2009, there is one period where the performance of SLT was almost 25% worse than the hedge fund industry in general, one period where they were almost the same, and one period where SLT outperformed the industry in general by 12%. At the request of the Court, Milczarek filed a chart comparing the inflows/outflows of SLT and of the hedge fund industry in general from 2002 to the first quarter of 2009. There is quite simply no correlation. It is impossible to come to any conclusion as to how SLT would have performed in the future by looking at the performance of the hedge fund industry in general.

[801]    The Plaintiffs needed to come up with a fund or a category of funds whose performance more closely mirrored the performance of SLT. They failed to do so.

[802]    Finally, there is the issue of causation. The Plaintiffs argue that the vast sell-off of SLT shares was not just a predictable consequence of the CRA’s abusive actions but that it was the CRA’s objective. The Court has already rejected that argument.

[803]    Moreover, there are serious reasons to expect that SLT’s failure to keep its shareholders might not be related to the conduct of the CRA.

[804]    First, SLT was structured in such a way as not to generate any income for its shareholders. Shareholders may not be interested in continuing that investment for the long term.

[805]    Further, the Plaintiffs pleaded, both during the audit and at the trial, that SLT had performed very well up until 2005 but that its shares had lost value in Canadian dollars since 2006. The following two passages from letters sent by the Plaintiffs’ counsel in 2009 and 2011 are cited by Viger to illustrate this point:

It is important to note, in this regard, that investor interest in SLT has evaporated because of SLT’s poor performance and investor preference for more conservative investments in light of the recent economic crisis. As a result of a changed economic climate (and not because of changes to tax laws), a number of SLT investors have chosen to dispose of their holdings in SLT; there have also been no new subscriptions for shares of SLT in quite some time.[515]

and

Of late, and again driven by economics, investor interest in SLT has declined because of the depreciation of the US dollar relative to the Canadian dollar, and investor preference for more conservative products in light of the current economic crisis. During the period 2005 to present, the share of SLT held by the Taxpayers have lost value when measured in Canadian dollars.[516]

[Bold in original; underlining added]

[806]    The Plaintiffs advanced this argument to justify their position that there should be no income attributed to them under Regulation 7000. However, the Court cannot ignore this argument as an explanation as to why shareholders were disposing of their SLT shares.

[807]    Moreover, the structure of SLT makes it more likely that there would be a snowball effect and that once some shareholders start selling, more would. SLT had a limited number of shareholders, most of whom were family or friends. The limited number of shareholders meant that each shareholder had a relatively large number of shares, and the relationship amongst the shareholders meant that when one sold, others were likely to know about it and to follow.

[808]      All of these factors lead the Court to reject as speculative Milczarek’s analysis, which has the effect of attributing the difference in inflow/outflow rates between SLT and the hedge fund industry in general to the conduct of the CRA.

[809]    Both the nature of the GAM payments and the failure to prove the causal link and to quantify the alleged loss lead the Court to dismiss this part of the claim.

5.    Stay of Sandringham reassessments and refund of tax paid by 4431472 and 4431481  

[810]    Further, the Plaintiffs ask for the Court to order a stay of the proposed reassessments relating to Sandringham, or to issue one of three subsidiary declarations with respect to those reassessments that would have the effect of ending or limiting the Sandringham reassessments. As a related matter, 4431472 and 4431481 ask for the refund of approximately $9 million that they paid in taxes for their 2008 to 2011 taxation years with respect to the GAM payments.

[811]    The Court has concluded that the proposed Sandringham reassessments are not unreasonable. Whether they are correct or not is not a matter for the Superior Court to decide. That question properly belongs in the Tax Court.

[812]    That is sufficient for the Court to dismiss the request for a stay of the proposed Sandringham reassessments and the subsidiary declarations that would have the effect of ending or limiting the Sandringham reassessments. It is not necessary for the Court to examine the issue of whether it even has jurisdiction to issue such an order.

[813]    The Court is concerned, however, about the issue of delay. Section 152 ITA requires the Minister to act “with all due dispatch” in examining a taxpayer’s return, assessing the tax for the year and determining the amount payable or to be refunded. The Minister then has three years to conduct an audit and reassess the taxpayer. The Sandringham issue has been a live issue since 2010 and has not yet been submitted to the Tax Court.

[814]    However, for an assessment under Section 160 ITA, Subsection (2) provides that the Minister may assess “at any time”. In Addison & Leyen, Justice Rothstein, dissenting in the Federal Court of Appeal, stated:

[92]       While in the sense identified by the majority, subsection 160(1) may be considered a harsh collection remedy, it is also narrowly targeted. It only affects transfers of property to persons in specified relationships or capacities and only when the transfer is for less than fair market value. Having regard to the application of subsection 160(1) in specific and limited circumstances, Parliament’s intent is not obscure. Parliament intended that the Minister be able to recover amounts transferred in these limited circumstances for the purpose of satisfying the tax liability of the primary taxpayer transferor. The circumstances of such transactions makes it clear that Parliament intended that there be no applicable limitation period and no other condition on when the Minister might assess.[517]

[Emphasis added]

[815]    The Supreme Court upheld Justice Rothstein’s dissent, stating that “the interpretation of s. 160 ITA by the majority of the Federal Court of Appeal amounted to reading into that provision a limitation period that was simply not there” (par. 9) and adding:

10         The Minister is granted the discretion to assess a taxpayer at any time.  This does not mean that the exercise of this discretion is never reviewable.  However, in light of the words “at any time” used by Parliament in s. 160 ITA, the length of the delay before a decision on assessing a taxpayer is made does not suffice as a ground for judicial review, except, perhaps, inasmuch as it allows for a remedy like mandamus to prod the Minister to act with due diligence once a notice of objection has been filed.  Moreover, in the case at bar, the allegations of fact in the statement of claim do not disclose any reason why it would have been impossible to deal with the tax liability issues relating to either the underlying tax assessment against York or the assessments against the respondents through the regular appeal process.[518]

[Emphasis added]

[816]    The Court does not agree with the Plaintiffs’ argument that the Supreme Court’s judgment in R. v. Jordan[519] interpreting the right of a person charged with an offence to be tried within a reasonable time under Section 11(b) of the Canadian Charter of Rights and Freedoms limits the Minister’s rights under Section 160 ITA. 

[817]    For these reasons, the Court will not issue any order staying the proposed reassessments or any of the subsidiary orders. As stated by the Supreme Court in Addison & Leyen, a remedy like mandamus might be appropriate to prod the Minister to act, but that issue was not argued. The CRA argues that only the Federal Court could grant that remedy.[520]

[818]    With respect to the tax refunds claimed by 4431472 and 4431481, the Court will not intervene at this time to order that the refunds be paid.

[819]    First, the issue as to whether the refunds are due has not yet been decided by any court. It is essentially the same issue as the larger Sandringham issue and the CRA seems to be postponing the consideration of the refund issue until the Sandringham issue is resolved. The amended returns for taxation years 2008 to 2010 were filed on April 27, 2011[521] and the amended returns for taxation year 2011 were filed on June 7, 2012.[522] The Court is concerned about the CRA postponing indefinitely the consideration of whether the refunds are due. It seems that the CRA should at least refuse the refunds to allow 4431472 and 4431481 to appeal to the Tax Court. Again it might be appropriate to proceed by mandamus, but that issue was not argued. As a result, it would not be appropriate for the Court to issue any order.

6.    Punitive damages

[820]    Finally, the Plaintiffs claim $40,000,000 in punitive damages for interference with their right to the peaceful enjoyment and disposition of their property and their right to reputation and for the abusive conduct of the Defendants.

[821]    Article 1621 C.C.Q. limits the awarding of punitive damages to cases where punitive damages are provided for by law.

[822]    This means that a plaintiff claiming punitive damages must point to a statute that applies in the circumstances of the case and that expressly provides that the court can award punitive damages.

[823]    The Plaintiffs invoke the Québec Charter of Human Rights and Freedoms:[523]

4. Every person has a right to the safeguard of his dignity, honour and reputation.

6. Every person has a right to the peaceful enjoyment and free disposition of his property, except to the extent provided by law.

[824]    The interference with property rights relates to the reassessments which forced the Ludmer SLT Plaintiffs to pay $14 million on the reassessments. The interference with reputation relates to the allegation of a criminal investigation to the Bermudan authorities.

[825]    Section 49 provides for punitive damages if the interference with the right is unlawful and intentional:

49. Any unlawful interference with any right or freedom recognized by this Charter entitles the victim to obtain the cessation of such interference and compensation for the moral or material prejudice resulting therefrom.

In case of unlawful and intentional interference, the tribunal may, in addition, condemn the person guilty of it to punitive damages.

[826]    The Supreme Court described as follows the operation of Section 49:

[164]      Section 49 of the Charter provides that, “[i]n case of unlawful and intentional interference, the tribunal may, in addition, condemn the person guilty of it to punitive damages.” This Court explained what “unlawful and intentional interference” means in Quebec (Public Curator) v. Syndicat national des employés de l’hôpital St-Ferdinand, [1996] 3 S.C.R. 211:

Consequently, there will be unlawful and intentional interference within the meaning of the second paragraph of s. 49 of the Charter when the person who commits the unlawful interference has a state of mind that implies a desire or intent to cause the consequences of his or her wrongful conduct, or when that person acts with full knowledge of the immediate and natural or at least extremely probable consequences that his or her conduct will cause. This test is not as strict as specific intent, but it does go beyond simple negligence. Thus, an individual’s recklessness, however wild and foolhardy, as to the consequences of his or her wrongful acts will not in itself satisfy this test. [Emphasis added; para. 121.]

[165]      In the instant case, given that the Ministers’ conduct cannot be equated with bad faith or serious recklessness, we cannot conclude that there was intentional interference. The evidence does not support a finding that the Ministers’ state of mind was such that they intended to harm Mr. Hinse or had knowledge of the adverse consequences their conduct would have for him. This stringent test was not met, and punitive damages should not have been awarded.[524]

[Emphasis in original]

[827]    The Court has already concluded that the mention of a criminal investigation was negligent but not intentional. No punitive damages will be awarded for that fault.

[828]    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 Ludmer or Steinberg. As a result, the Court concludes that the CRA officers did not intentionally interfere with Ludmer and Steinberg’s property rights. No punitive damages will be awarded for that fault.

[829]    The remaining allegation is that the CRA acted abusively. Even if that was true, it would not attract punitive damages in the absence of a statute proving a right to punitive damages.

[830]    For these reasons, the claim for punitive damages will be dismissed.

CONCLUSION

[831]    For all of the foregoing reasons, the Court will grant the action in part:

1.    The Court will award $1,497,223.19 to the Ludmer SLT Plaintiffs on a pro rata basis to reimburse them for the lost interest on the mandatory payments they were required to make on the reassessments;

2.    The Court will award $3,097,435.66 damages to the SLT Plaintiffs with respect to the professional fees that they incurred, to be apportioned among them pro rata to the invoices produced; and

3.    The Court will award $100,000 to Ludmer and $50,000 to Steinberg for damage to their reputations and $50,000 to each of Ludmer and Steinberg for stress, trouble and inconvenience.

[832]    The amounts awarded to each Plaintiff are as follows:

 

Plaintiff	Lost interest	Professional fees	Damage to reputation	Stress, trouble, inconvenience	Total
Ludmer			$100,000.00	$50,000.00	$150,000.00
3488055	$30,904.75	$75,695.68			$106,600.43
3488063	$31,545.04	$75,660.03			$107,205.07
3488071	$30,248.43	$75,654.53			$105,902.96
2534-2825	$1,030,671.50	$1,035,803.97			2,066,475.47
4077211	$373,853.47	$302,288.61			$676,142.08
Steinberg			$50,000.00	$50,000.00	$100,000.00
Habland		$146,211.53			$146,211.53

 

Stoneview		$747,677.29			$747,677.29
3421848		$638,444.02			$638,444.02
TOTAL	$1,497,223.19	$3,097,435.66	$150,000.00	$100,000.00	$4,844,658.85

[833]    The remaining claims put forward by the Plaintiffs will be dismissed.

[834]    Costs will be awarded to the Plaintiffs. Those costs will not include the expert fees of Mareval S.E.N.C.R.L. since the Court did not retain the conclusions of that report.

[835]    Finally, the Court thanks the attorneys for both sides for their work in this file and apologizes to the parties for the delay in issuing this judgment.

FOR THESE REASONS, THE COURT:

[836]    MAINTAINS in part the Re-Re-Amended and Re-Particularized Motion to Institute proceedings filed by the Plaintiffs;

[837]    CONDEMNS the Attorney General of Canada and the Canada Revenue Agency, solidarily, to pay to the Plaintiffs the following amounts:

 

 

Irving Ludmer	$150,000.00
3488055 Canada Inc.	$106,600.43
3488063 Canada Inc.	$107,205.07
3488071 Canada Inc.	$105,902.96
2534-2825 Québec Inc.	$2,066,475.47
4077211 Canada Inc.	$676,142.08

 

Mark Brender, Phil Nadler, Margot Steinberg and Donna Steinberg as liquidators of the Estate of the late Arnold Steinberg	$100,000.00
Habland Investments Inc.	$146,211.53
Stoneview Inc.	$747,677.29
3421848 Canada Inc.	$638,444.02

with interest at the legal rate and the additional indemnity provided for at article 1619 C.C.Q. from the date of institution of the proceedings;

[838]    THE WHOLE, with costs, save the expert fees of Mareval S.E.N.C.R.L.

		__________________________________ Stephen W. Hamilton, J.S.C.
Mtre Douglas Mitchell Mtre David Grossman Mtre Francis Legault-Mayrand
IRVING MITCHELL KALICHMAN
For the Plaintiffs
Mtre David Lucas Mtre Sébastien Gagné Mtre Valérie Messore Mtre Sarom Bahk
MINISTÈRE DE LA JUSTICE CANADA
For the Defendants
Dates of hearing:	September 2016: 6,7,8,12,13,14,15,19,20,21,22,26,27,28,29,30
	October 2016: 3,4,5,17,18,19,20,24,25,26,27,31
	November 2016: 1,2,3,14,15,16,17,21,23,24
	December 2016: 12,13,14,15,16

 

APPENDIX 1 - Legislative Context

[839]    It is useful to review a number of concepts under the ITA. For the purposes of this review, the Court will refer to the ITA as it stood on January 1, 2009, when the Ludmer audit formally began. When the Court refers to an earlier or later version of the ITA, it will make that clear.

General procedure in tax matters

[840]    It is useful to begin with a quick review of how taxation works procedurally - who files what and when.

1.    Liability for tax

[841]    The general rule in Canadian tax law is that a Canadian resident is taxable on his or her world-wide income.[525] A non-resident is only liable for Canadian tax on his Canadian income.[526]

[842]    “World-wide” income means all income “from a source inside or outside Canada”.[527]

[843]    Income includes “the taxpayer’s income for the year from each office, employment, business and property”[528] as well as taxable capital gains.[529] These sources are defined quite broadly.[530]

[844]    When a taxpayer holds a passive investment, he is generally liable to pay tax in two ways:

·        the distributions, such as dividends, interest, rents or royalties, are taxable as income from a business or from property when they are received;[531] and

·        the proceeds of disposition are taxable if the taxpayer realizes a capital gain.[532]

[845]    If the taxpayer receives an amount which cannot be characterized as income from an office, employment, business or property and which is not a capital gain, it is not taxable.

2.    Tax returns

[846]    Canada’s tax system is a self-reporting system, in which every taxpayer has the obligation to complete and file a tax return by April 30 of the following year for individuals, within 90 days of the end of the taxation year for a trust, and within six months of the end of the taxation year for a corporation.[533]

[847]    The taxpayer has the obligation to estimate the amount of tax payable in his tax return[534] and to pay the balance due by the due date for the tax return.[535] The taxpayer will be required to pay interest if he does not pay on time or if he underestimates the amount payable.[536]

3.    Assessments and reassessments

[848]    The ITA requires the Minister to examine the taxpayer’s tax return “with all due dispatch”, assess the tax, interest and penalties payable, and issue a notice of assessment to the taxpayer.[537]

[849]    The Minister then has three years to conduct an audit and reassess the taxpayer.[538] The three year limitation does not apply in cases of misrepresentation attributable to neglect, carelessness or wilful default, or in cases of fraud.[539] The burden is on the Minister to prove on the balance of probabilities the facts justifying assessing under that exception.

[850]    The three years can be extended if the Minister obtains a waiver from the taxpayer within the three-year period.[540]

[851]    The practice in this area when the three-year limit is approaching is for the Minister to request a waiver. If the taxpayer grants the waiver, then the audit continues. If the taxpayer refuses the waiver or grants the waiver and then revokes it, the Minister issues a “protective reassessment” to stop the clock from running out.

4.    Notice of objection

[852]    Once the taxpayer receives a notice of assessment or a notice of reassessment with which he disagrees, the taxpayer has 90 days to file a notice of objection.

[853]    After the CRA reviews the notice of objection, the CRA will reconsider the assessment and either issue a notice of confirmation of the original assessment or reassessment or will issue a new notice of reassessment.[541]

5.    Appeals to the Tax Court

[854]    Once the taxpayer receives the CRA’s decision on the notice of objection, the taxpayer has 90 days to appeal the notice of confirmation or the notice of reassessment to the Tax Court of Canada.[542]

[855]    Alternatively, the taxpayer can appeal the original assessment or the reassessment directly to the Tax Court of Canada if the CRA has not responded to the notice of objection in 90 days.

[856]    The notice of assessment or notice of reassessment is deemed to be valid and binding, and the burden is on the taxpayer to show that the assessment or reassessment is invalid.[543]

6.    Payments, refunds and interest

[857]    If the taxpayer does not object to the assessment or reassessment and does not file an appeal to the Tax Court, the taxpayer must pay the amount in full within 90 days.

[858]    The filing of a notice of objection or an appeal operates as a stay of the enforceability of the assessment or reassessment, unless the taxpayer is a large corporation. A large corporation must pay one-half of the amount due under the assessment or reassessment within 90 days,[544] and the enforceability of the other one-half is stayed.

[859]    Any unpaid amounts which are ultimately found to be due are payable with interest compounded daily from the date that the tax was payable. The rate of interest is fixed every three months as the rate on Government of Canada Treasury Bills (rounded up to the next higher whole percentage) plus 4%.[545] Between 2009 and today, the rate has been 5%, except for two quarters when it was 6%.[546]

[860]    On the other hand, any amounts which are paid and are ultimately found not to be due are reimbursed with interest. Corporations receive interest at the Treasury Bill rate, and other taxpayers receive the Treasury Bill rate plus 2%.[547] These rates have been 1% (corporations) and 3% (non-corporations) throughout the period since 2009, except for two quarters where they were 2% and 4% respectively.[548]

7.    Penalties

[861]    Because the system is self-reporting and self-assessing, and to encourage disclosure and accuracy, the ITA provides for a variety of penalties to taxpayers who, in certain circumstances, fail to comply with their obligations:

·        Late-filing penalty: If the taxpayer owes tax and does not file his return on time, he is charged a late-filing penalty equal to the total of 5% of the balance owing, plus 1% of the balance owing for each full month the return is late, to a maximum of 12 months.[549] If the taxpayer repeatedly files late, the late-filing penalty may increase to 10% of the balance owing, plus 2% of the balance owing for each full month the return is late, to a maximum of 20 months.[550]

·        Failure to file an information return penalty: If the taxpayer fails to file an information return required by the ITA or to comply with a duty or obligation imposed by the ITA, the penalty is $100 or $25 per day up to a maximum of $2,500.[551]

·        Repeated failure to report income penalty: If the taxpayer fails to report an amount on his return (whether intentionally or in error), and also failed to report an amount in any of the previous three years’ returns, he may have to pay a repeated failure to report income penalty equal to 10% of the amount that he failed to report on the current return.[552]

·        False statements or omissions penalty: If the taxpayer knowingly, or under circumstances amounting to gross negligence, made a false statement or omission on his tax return, the taxpayer may be charged a penalty equal to the greater of $100; and 50% of the understated tax and/or the overstated credits related to the false statement or omission.[553]

[862]    There are specific penalties with respect to the reporting of foreign property:

·        If the taxpayer knowingly or under circumstances amounting to gross negligence fails to report foreign property, there is also a penalty of $500 per month up to 24 months[554] or 5% of the cost of the foreign property if the delay exceeds 24 months;[555] and

·        If the taxpayer knowingly or under circumstances amounting to gross negligence makes a false statement or omission in a return relating to foreign property, the penalty is the greater of $24,000 or 5% of the cost of the foreign property.[556]

[863]    Because the reports are due within 15 months after the end of the taxpayer’s taxation year, the 5% penalty applies only if the report is filed more than 39 months after the end of the taxpayer’s taxation year (15 months to file + 24 months late).

[864]    Penalties are not imposed automatically. The Minister has the discretion to waive penalties as well as interest:

220 (3.1) The Minister may, on or before the day that is ten calendar years after the end of a taxation year of a taxpayer (or in the case of a partnership, a fiscal period of the partnership) or on application by the taxpayer or partnership on or before that day, waive or cancel all or any portion of any penalty or interest otherwise payable under this Act by the taxpayer or partnership in respect of that taxation year or fiscal period, and notwithstanding subsections 152(4) to (5), any assessment of the interest and penalties payable by the taxpayer or partnership shall be made that is necessary to take into account the cancellation of the penalty or interest.

[Emphasis added]

[865]    The Taxpayer Relief Provisions describe how the CRA exercises that discretion:

¶ 25. Penalties and interest may be waived or cancelled in whole or in part where they result from circumstances beyond a taxpayer’s control. …

…

¶ 33. Where circumstances beyond a taxpayer’s control, actions of the CRA, or inability to pay or financial hardship has prevented the taxpayer from complying with the Act, the following factors will be considered when determining whether or not the CRA will cancel or waive penalties and interest: (a) whether or not the taxpayer has a history of compliance with tax obligations; (b) whether or not the taxpayer has knowingly allowed a balance to exist on which arrears interest has accrued; (c) whether or not the taxpayer has exercised a reasonable amount of care and has not been negligent or careless in conducting their affairs under the self-assessment system; and (d) whether or not the taxpayer has acted quickly to remedy any delay or omission.[557]

8.    Voluntary disclosure

[866]    Finally, the CRA has a Voluntary Disclosure Program[558] whereby a taxpayer who has made an incomplete or incorrect filing and who is not under audit can voluntarily disclose the issue to the CRA.

[867]    The taxpayer makes an initial disclosure on a no-name basis. The disclosure is reviewed.

[868]    If it is accepted, the taxpayer will be required to pay the tax that was due, but not the interest and penalties.

[869]    If it is refused, then the taxpayer may be charged with the unpaid taxes, plus interest and penalties. The CRA can refuse a disclosure as not being “voluntary” if either:

·        the taxpayer was aware of, or had knowledge of an audit, investigation or other enforcement action set to be conducted by the CRA, with respect to the information being disclosed to the CRA, or

·        enforcement action had been initiated by the CRA on a person associated with the taxpayer that was sufficiently related to the disclosure and was likely to uncover the information being disclosed.

Tax avoidance

[870]    In principle, taxpayers are entitled to organize their affairs so as to pay the least amount of tax.[559]

[871]    However, the ITA provides a number of rules to prevent taxpayers from avoiding taxes otherwise payable.

[872]    The tax avoidance rules relevant in this matter are the following:

·        Interest is deemed to accrue (and is therefore included as income) on “prescribed debt obligations”;

·        Indirect payments are deemed to be received directly by the taxpayer;

·        The undistributed income of a non-resident corporation is taxable in the hands of its Canadian-resident shareholders in certain circumstances;

·        Certain non-resident trusts are deemed to be resident in Canada for certain purposes; and

·        Finally, the ITA includes a general anti-avoidance rule (“GAAR”) that allows the CRA to deny a tax benefit when the taxpayer enters into an “avoidance transaction”.

1.    Regulation 7000

[873]    Amounts received or receivable by the taxpayer in the year as interest are taxable as income.[560] In addition, interest that accrues during the year is taxable income.[561]

[874]    Regulation 7000 provides for a deemed accrual of interest (which is therefore included as income) on “prescribed debt obligations”.[562] The purpose is to ensure that a taxpayer does not defer the recognition of interest (and thereby defer the payment of tax) until cash settlement.

[875]    Regulation 7000(1) and (3) define four categories of “prescribed debt obligation” as follows:

7000 (1) For the purpose of subsection 12(9) of the Act, each of the following debt obligations (other than a debt obligation that is an indexed debt obligation) in respect of which a taxpayer has at any time acquired an interest is a prescribed debt obligation:

(a) a particular debt obligation in respect of which no interest is stipulated to be payable in respect of its principal amount,

(b) a particular debt obligation in respect of which the proportion of the payments of principal to which the taxpayer is entitled is not equal to the proportion of the payments of interest to which he is entitled,

(c) a particular debt obligation, other than one described in paragraph (a) or (b), in respect of which it can be determined, at the time the taxpayer acquired the interest therein, that the maximum amount of interest payable thereon in a year ending after that time is less than the maximum amount of interest payable thereon in a subsequent year, and

(d) a particular debt obligation, other than one described in paragraph (a), (b) or (c), in respect of which the amount of interest to be paid in respect of any taxation year is, under the terms and conditions of the obligation, dependent on a contingency existing after the year,

and, for the purposes of this subsection, a debt obligation includes, for greater certainty, all of the issuer’s obligations to pay principal and interest under that obligation.

…

(3) For the purpose of this section, any bonus or premium payable under a debt obligation is considered to be an amount of interest payable under the obligation.

[876]    The parties argue that either Regulation 7000(1)(a) or 7000(1)(d) applies.

[877]    The income inclusions with respect to the prescribed debt obligations in Regulation 7000(1)(a) or 7000(1)(d) are as follows:

(2) For the purposes of subsection 12(9) of the Act, the amount determined in prescribed manner that is deemed to accrue to a taxpayer as interest on a prescribed debt obligation in each taxation year during which he holds an interest in the obligation is,

(a) in the case of a prescribed debt obligation described in paragraph (1)(a), the amount of interest that would be determined in respect thereof if interest thereon for that year were computed on a compound interest basis using the maximum of all rates each of which is a rate computed

(i) in respect of each possible circumstance under which an interest of the taxpayer in the obligation could mature or be surrendered or retracted, and

(ii) using assumptions concerning the interest rate and compounding period that will result in a present value, at the date of purchase of the interest, of all the maximum payments thereunder, equal to the cost thereof to the taxpayer;

…

 (d) in the case of a prescribed debt obligation described in paragraph (1)(d), the maximum amount of interest thereon that could be payable thereunder in respect of that year.

2.    Indirect payments

[878]    Section 56(2) ITA provides that a payment which the taxpayer directs to a third party for the benefit of the taxpayer may be taxable in the hands of the taxpayer as if received directly by the taxpayer:

(2) A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person (other than by an assignment of any portion of a retirement pension pursuant to section 65.1 of the Canada Pension Plan or a comparable provision of a provincial pension plan as defined in section 3 of that Act or of a prescribed provincial pension plan) shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to the taxpayer.

[879]    The purpose of this provision is to prevent the taxpayer from reducing his or her income by transferring property or directing a payment to a third party.

[880]    There are four conditions for Section 56(2) ITA to attribute income to a taxpayer:

1.    There must be a payment (or transfer of property) to a person other than the taxpayer;

2.    The payment must be made pursuant to the direction of the taxpayer or with his concurrence;

3.    The payment must be for the benefit of the taxpayer, or the taxpayer must desire to confer the benefit on the other person; and

4.    The payment would have been included in the taxpayer’s income if it had been made to the taxpayer.

[881]    If these conditions are met, then the payment is taxable as if received by the taxpayer.

[882]    Moreover, Section 160 ITA provides that where a taxpayer transfers property directly or indirectly not at arm’s length and for insufficient consideration, the transferee and the transferor are solidarily liable for the lesser of (1) the transferor’s liability for tax for the year of the transfer and any prior year, or (2) the difference between value of what was transferred and the consideration received for the transfer.

3.    Taxation of foreign investment income

3.1   Definitions

[883]    Under common law principles, a corporation is resident in the country in which its central management and control is exercised. SLT is therefore a non-resident entity which is a non-resident corporation. The identity and exact legal nature of the funds held by SLT is not in evidence, but all parties accept that they are non-resident entities.

[884]    The notion of “foreign affiliate” is relatively straightforward: (1) the taxpayer must hold at least 1% of the equity of the foreign corporation, and (2) the taxpayer and persons related to the taxpayer must hold at least 10%.[563] SLT was a foreign affiliate of SLT Plaintiffs other than 3488055, 3488063 and 3488071, who each held less than 1% of the shares of SLT. For those shareholders, their shares are foreign property but SLT is not a foreign affiliate.

[885]    The notion of “controlled foreign affiliate” is more complicated. The foreign corporation must be a foreign affiliate of the taxpayer, and therefore the two conditions set out above must be met. In addition, the foreign corporation must be “controlled”. This can be met in one of two ways:

·        The taxpayer together with persons related to the taxpayer own more than 50% of the equity; or

·        The taxpayer and persons related to the taxpayer, together with at most four other Canadian taxpayers and persons related to those taxpayers own more than 50% of the equity.[564]

[886]    The second part of the definition of “controlled foreign affiliate” therefore requires knowledge of the other shareholders and the relationships among them.

[887]    It is important to note that the definition of “controlled foreign affiliate” came into force on December 14, 2007 with effect retroactive for taxation years beginning after 2002.

[888]    The CRA has performed a detailed analysis of the shareholdings in SLT over time and the relationships among the shareholders, and has concluded that SLT was a controlled foreign affiliate of the SLT Plaintiffs for the following years:

·        4077211 and 2534-2825: 2003 to 2009;[565]

·        3421848: 2006 to 2009;[566]

·        Stoneview: 2003 to 2009.[567]

[889]    Those conclusions have not been challenged, although the Plaintiffs plead that they did not have access to the information required to make the analysis.

3.2   Reporting of foreign property

[890]    A taxpayer who owns shares in a foreign company must file one of three information returns:

1.    Form T1135 if the taxpayer owns foreign property (including shares in a foreign corporation) with a cost of more than $100,000, but the foreign corporation is not a “foreign affiliate” of the taxpayer;

2.    Form T1134A if the foreign corporation is a “foreign affiliate” but not a “controlled foreign affiliate” of the taxpayer; or

3.    Form T1134B if the foreign corporation is a “controlled foreign affiliate” of the taxpayer.

[891]    The information required with each form varies:

·        Form T1135 requires only a description of the type of property, the range of the total cost of the investment, the location of the investments and the total income reported from the assets. It does not require identification of each asset;

·        Form T1134A must be filed with respect to each foreign affiliate. It requires details of the taxpayer’s shareholding and financial information with respect to the foreign affiliate; and

·        Form T1134B is more detailed with respect to the financial information required with respect to the controlled foreign affiliate.

[892]    Form T1135 must be filed with the tax return for the taxation year or fiscal period. Forms T1134A and B must be filed within 15 months of the end of the taxation year or fiscal period.

[893]    The purpose of the more detailed Forms T1134A and B is to enable the CRA to assess whether the taxpayer has properly reported his income from the foreign corporation.

[894]    The taxpayer is not required to file information that is not available on the day on which the return is filed, provided that (1) there is reasonable disclosure in the return of the unavailability of the information, (2) the taxpayer exercised due diligence in attempting to obtain the information, and (3) the information is filed within 90 days after it becomes available to the taxpayer.[568]

3.3   Rules in force at the relevant time

[895]    The general rules set out above apply to foreign investments. Under those rules, a Canadian resident who earns dividends, interest or capital gains from foreign investments is taxable on that income in Canada.

[896]    However, if that Canadian resident earns foreign income through a foreign corporation, the income is not taxable in Canada under the general rules: the foreign corporation is not subject to tax in Canada because it is not resident in Canada and does not earn any Canadian source income, and the Canadian-resident shareholder is not subject to tax because he or she has not earned any income. The Canadian-resident taxpayer is only subject to Canadian tax when the non-resident corporation distributes the income to him as a dividend,[569] or when he disposes of the shares.  A Canadian resident can therefore defer taxation indefinitely by leaving the foreign income earned through the foreign corporation in the foreign corporation and not distributing it. Moreover, by selling his shares in the foreign corporation before the income is distributed, the taxpayer can convert the undistributed income into a capital gain, only half of which is taxable.

[897]    Parliament has adopted specific rules to eliminate these tax advantages by providing that certain types of foreign investment income are taxed in the hands of the Canadian-resident shareholders prior to distribution or disposition.

3.3.1    OIF rules

[898]    The first provision is Section 94.1 ITA. It applies to an interest in a non-resident entity (other than a CFA, to which the FAPI rules set out below apply), referred to as an “offshore investment fund property” (“OIF”), that derives its value directly or indirectly from “portfolio investments” of any non-resident entity in certain types of assets:

94.1 (1) Where in a taxation year a taxpayer, other than a non-resident-owned investment corporation, holds or has an interest in property (in this section referred to as an “offshore investment fund property”)

·         (a) that is a share of the capital stock of, an interest in, or a debt of, a non-resident entity (other than a controlled foreign affiliate of the taxpayer or a prescribed non-resident entity) or an interest in or a right or option to acquire such a share, interest or debt, and

·         (b) that may reasonably be considered to derive its value, directly or indirectly, primarily from portfolio investments of that or any other non-resident entity in

o    (i) shares of the capital stock of one or more corporations,

o    (ii) indebtedness or annuities,

o    (iii) interests in one or more corporations, trusts, partnerships, organizations, funds or entities,

o    (iv) commodities,

o    (v) real estate,

o    (vi) Canadian or foreign resource properties,

o    (vii) currency of a country other than Canada,

o    (viii) rights or options to acquire or dispose of any of the foregoing, or

o    (ix) any combination of the foregoing,

(Emphasis added)

[899]    Section 94.1 ITA only applies if, based on the factors set out in paragraphs (c) to (e), one of the main reasons for acquiring or holding the OIF is to reduce Canadian tax (referred to as the “motive test”):

… one of the main reasons for the taxpayer acquiring, holding or having the interest in such property was to derive a benefit from portfolio investments in assets described in any of subparagraphs 94.1(1)(b)(i) to 94.1(1)(b)(ix) in such a manner that the taxes, if any, on the income, profits and gains from such assets for any particular year are significantly less than the tax that would have been applicable under this Part if the income, profits and gains had been earned directly by the taxpayer …

[900]    If the two tests are met (the nature of the investment and the motive test), then the taxpayer must include in his income the difference between a notional return on the cost of the OIF and his actual income from the OIF:

… there shall be included in computing the taxpayer’s income for the year the amount, if any, by which

(f) the total of all amounts each of which is the product obtained when

(i) the designated cost to the taxpayer of the offshore investment fund property at the end of a month in the year

is multiplied by

(ii) the quotient obtained when the prescribed rate of interest for the period including that month is divided by 12

exceeds

(g) the taxpayer’s income for the year (other than a capital gain) from the offshore investment fund property determined without reference to this subsection.

3.3.2    FAPI

[901]    The second provision is the “foreign accrual property income” (“FAPI”) rule in Sections 91 to 95 ITA. Under this rule, a Canadian taxpayer with a controlled foreign affiliate must add to his income for the year his share of certain types of passive income (defined as the FAPI) of the controlled foreign affiliate:

91 (1) In computing the income for a taxation year of a taxpayer resident in Canada, there shall be included, in respect of each share owned by the taxpayer of the capital stock of a controlled foreign affiliate of the taxpayer, as income from the share, the percentage of the foreign accrual property income of any controlled foreign affiliate of the taxpayer, for each taxation year of the affiliate ending in the taxation year of the taxpayer, equal to that share’s participating percentage in respect of the affiliate, determined at the end of each such taxation year of the affiliate.

(Emphasis added)

[902]    The definition of FAPI is complex.^[570] Two elements of the definition of FAPI are relevant for the purposes of this matter:

·        Element A includes the FA’s income for the year from property, which would include interest on a note. Interest is calculated in accordance with Section 12 ITA, which includes Regulation 7000 when it is applicable; and

·        Element C includes the CFA’s income if Section 94.1 ITA was applicable, which means the CFA’s deemed income on its “portfolio investments” if the “motive test” is met. This element is not dependent on Regulation 7000.

[903]    The result is that if a Canadian-resident shareholder holds shares in a non-resident corporation that has undistributed income, the taxpayer will have income imputed to him:

1.   if the non-resident corporation is not a controlled foreign affiliate and meets the test for an OIF and if the taxpayer meets the motive test, or

2.   if the non-resident corporation is a controlled foreign affiliate of the taxpayer.

[904]    In the first case, the non-CFA taxpayer must include the difference between a notional return on the cost of his investment and his actual income, and in the second, the CFA taxpayer must include the pro rata share of the non-resident corporation’s FAPI.

3.4   Proposed FIE rules

[905]    In 1999, the government proposed to replace Section 94.1 ITA with a set of rules called the “foreign investment entity” (“FIE”) rules. These rules would not apply to controlled foreign affiliates, to which the FAPI rule would continue to apply (except that Element C of the definition of FAPI would no longer apply because of the repeal of Section 94.1 ITA).

[906]    In other words, the proposed FIE rules would do away with the motive test. Instead, under the proposed FIE rules, the taxpayer who owns a participating interest in a “foreign investment entity” would be required to include in his income for the year one of the following three amounts:

1.            a notional return on his investment calculated by multiplying his cost by a notional return (similar to the calculation under the current Section 94.1 ITA)

2.            the “mark to market” return, which represents the difference in the market value of the investment from one year to the next; or

3.            his share of the income of the foreign entity (similar to the FAPI rules).

[907]    The proposed FIE rules were carried forward from budget to budget but were never adopted by Parliament.[571]

[908]    Finally, in the 2010 budget released on March 4, 2010, the Minister of Finance announced that he was abandoning the proposed FIE rules in favour of “limited enhancements” to the OIF rules in the current Section 94.1 ITA.[572]

3.5   CIF rules

[909]    When new tax legislation is announced, the Minister generally announces that, when it is enacted, it will have effect retroactive to the time that it was announced. This is done through the coming-into-force (“CIF”) or “grandfathering” provisions of the new tax legislation. As a result, the common practice of the CRA is to encourage taxpayers to follow new tax legislation as soon as it is announced, even if it has not yet been enacted.

[910]    This is what happened with the proposed FIE rules. The CRA encouraged taxpayers to file their tax returns in conformity with the proposed FIE rules as early as 2001, the date on which those new rules were intended to come into force. That position continued until the proposed FIE rules were abandoned on March 4, 2010.

[911]    For that reason, the CIF provisions for the amendments to Section 94.1 ITA in the 2010 budget provided rules for determining the income tax treatment of a taxpayer who had voluntarily complied with the proposed FIE rules before March 4, 2010.

[912]    Essentially, the CIF rules provided that a taxpayer who had voluntarily complied with the proposed FIE rules between 2001 and March 4, 2010 would be taxed under the proposed FIE rules for those years rather than the former Section 94.1 ITA. The proposed CIF rules were announced on August 27, 2010.[573] The CIF rules which came into force on June 26, 2013 did not materially differ from the original version released in August 2010,[574] and provide as follows:

8. (5) Subsection (6) applies to a taxpayer for each taxation year that ends in the period that begins on January 1, 2001 and ends on March 4, 2010 (referred to in this subsection and subsections (7), (8) and (10) as the “relevant period”), if

(a) in the return of income for the year the taxpayer has, in respect of one or more participating interests held by the taxpayer during the relevant period, in this subsection and subsections (6) to (10) having the meaning of “participating interest” as set out in the provisions of sections 94.1 to 94.4 of the Act contained in section 18 of Bill C-10 of the second session of the 39th Parliament as passed by the House of Commons on October 29, 2007, included or deducted an amount (referred to in this subsection and subsections (6) to (8) and (10) as the “reported inclusion” or “reported deduction” as the case may be) under those provisions in computing income for the year; and

(b) the taxpayer files a prescribed form on or before the taxpayer’s filing-due date for the taxpayer’s taxation year in which this Act receives royal assent

(i) identifying each participating interest of the taxpayer for which a reported inclusion or reported deduction described in paragraph (a) has been included, or deducted, in computing the taxpayer’s income for a taxation year ending in the relevant period, and

(ii) providing sufficient detail of each of those participating interests, including any reported inclusions, reported deductions, and any taxable capital gains or allowable capital losses realized on the participating interests described in subparagraph (i).

(6) If this subsection applies to a taxpayer for a taxation year,

(a) the taxpayer’s reported inclusion and any taxable capital gains for the year in respect of a participating interest is deemed to be the amount required to be included under the Act in computing the taxpayer’s income for that year in respect of that participating interest; and

(b) the taxpayer’s reported deduction and any allowable capital loss for the year in respect of a participating interest is deemed to be the amount deductible under the Act in computing the taxpayer’s income, or the allowable capital loss, respectively, for that year in respect of that participating interest.[575]

(Emphasis added)

[913]    The CIF rules therefore required that:

1.          The taxpayer comply with the proposed FIE rules by including or deducting in his tax returns the amount required by the proposed FIE rules; and

2.          The taxpayer file the prescribed form on or before the taxpayer’s filing-due date for the taxpayer’s taxation year in which the CIF rules were adopted.

[914]    If the taxpayer complied with the CIF rules, the effect was that the reported inclusion or deduction, which was in conformity with the proposed FIE rules, was deemed to be the amount required to be included or deducted under the ITA, even though it was not in accordance with Section 94.1 ITA.

[915]    One of the issues in connection with the CIF rules is that they came into force on June 26, 2013 and therefore the taxpayer was required to file the prescribed form on or before the taxpayer’s next filing-due date. The prescribed form was not in fact available until much later.

4.    Taxation of non-resident trusts

[916]    A non-resident trust in principle does not pay any tax in Canada on its foreign income. Section 94 ITA provides that a non-resident trust is deemed to be a person resident in Canada and is therefore liable to pay tax in Canada on its foreign income in certain circumstances.

[917]    Between 1995 and 2006, Section 94(1) ITA provided two conditions for its application:

1.          a person resident in Canada is the beneficiary of a non-resident trust; and

2.          the trust acquired property, directly or indirectly in any manner whatever from that beneficiary.

[918]    If these conditions were met, the trust was deemed to be a person resident in Canada for the purpose of Part I of the ITA, and the income of the trust was calculated by reference to the FAPI rules.

[919]    After 2007, Section 94(3) ITA applies when a Canadian resident makes a contribution to a non-resident trust other than an “arm’s length transfer”.

[920]    In that event, the non-resident trust is deemed to be a person resident in Canada and is taxable on its world-wide income.

[921]    In either event, the resident beneficiary or resident contributor is solidarily liable with the non-resident trust.[576]

5.    GAAR

[922]    Finally, the ITA includes a general anti-avoidance rule (“GAAR”) in Section 245 ITA:

(2) Where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that, but for this section, would result, directly or indirectly, from that transaction or from a series of transactions that includes that transaction.

(3) An avoidance transaction means any transaction

(a) that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit; or

(b) that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.

[923]    This provision allows the CRA to deny a tax benefit and impose the reasonable tax consequences in the case of a transaction arranged primarily to obtain the tax benefit.