It’s not easy to recover damages from the CRA for an unfair audit

For a brief period of time, it looked like the courts were willing to award individuals and businesses damages for malicious prosecution by the CRA. In a 2018 BC case, the court found that a CRA investigator decided from the outset that the owners of a restaurant and nightclub in Nanaimo, B.C. were guilty of tax evasion, and set out to prove his case by suppressing evidence and filing misleading reports. After a 19-day trial led to their acquittal on all 21 counts of tax evasion, the owners successfully sued the CRA, and were awarded over $1 million in legal fees, aggravated damages, and punitive damages for the investigator’s malicious conduct. The CRA appealed, and the Court of Appeal determined there was reasonable and probable cause for the CRA investigator to bring the tax evasion charges in the first place, and therefore the claim for malicious prosecution was not available. The appeal court noted the trial judge had relied too much on hindsight and the findings of fact at the lower court, and the decision was overturned.

In a more recent decision, a lay litigant sued the CRA for misfeasance in public office, breach of fiduciary duty, and improper assessment and collection of taxes. The court noted that only the Tax Court of Canada has jurisdiction to challenge the validity of a tax assessment, and granted the CRA’s application to strike the pleadings, which were found to be inadequate.

Kenneth Kolarsky
Shareholders may become liable for a corporation’s taxes

It is well-established in law that the shareholders of a corporation are generally immune from the the debts of the corporation.* This includes tax debts of a corporation. However, a shareholder who receives dividends from a corporation that owes tax may become liable for part or all of the corporation’s tax debt under section 160 of the Income Tax Act. That section applies when a tax debtor transfers property to a non-arm’s length party for inadequate consideration. There is no limitation period for a section 160 reassessment, so the CRA can reach through the corporation to recover its tax debt from the shareholder at any point in future. Whenever bankruptcy or dissolution is considered for an insolvent corporation, any potential future implications for shareholders under section 160 should therefore be considered. If the CRA does not succeed in recovering from the corporation, it may redirect collection efforts toward a shareholder. In a case before the Alberta courts now, a shareholder was reassessed under section 160 for almost $1.8M - the amount of a dividend it had received. The shareholder then sued its tax counsel for negligence approximately 10 years after receiving legal advice in relation to the dividend. The lawyers recently failed in their application to dismiss the lawsuit for delay, so it remains to be seen who will ultimately pay the corporation’s tax debt - the shareholder or its legal counsel.

*There are exceptions to this general principle.

Kenneth Kolarsky
However....It may be difficult for shareholders to sue for negligent professional advice

In Brunette v. Legault Joly Thiffault, s.e.n.c.r.l., 2018 SCC 55, the Supreme Court of Canada dismissed an action brought by a shareholder/plaintiff against the corporation’s accountants and lawyers for allegedly faulty tax advice that resulted in a $55M loss to the corporation. The court at the Superior Court level determined that shareholders have no separate cause of action against a third party (here, professional advisors) unless that third party owes a distinct legal obligation to them as shareholders, and that obligation has been breached. In this case, the court determined the corporation (as opposed to the shareholder) had suffered a loss - namely, diminished value of its assets. The Court of Appeal of Quebec unanimously agreed. The Supreme Court of Canada upheld that decision, based on the principle of a corporation’s distinct legal liability - originating in Foss v. Harbottle, a 19th century English case. Given that incorporation limits the liability of shareholders, it also restricts the ability of shareholders to recover for wrongs committed against the corporation. This is a threshold question for any cause of action: where the pleadings do not allege a breach of an independent legal obligation owed to the shareholder, the action may be dismissed. The court noted there are other possible remedies to a shareholder, such as derivative actions under corporate statutes, but a shareholder otherwise has no direct cause of action for wrongs against a corporation. 

Kenneth Kolarsky