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COURT CASES


Company wins $4,000,000
in Punitive Damages against CRA - Quebec
CRA's abusive audit and bad faith
Tax Authority's Misbehaviour

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A Montreal businessman who was forced to shut down his business after Quebec tax authorities mishandled his case was awarded nearly $4 million, including a staggering $2 million in punitive damages, following a precedent-setting ruling by Quebec Superior Court.In an extremely harsh judgment that sheds light on Revenue Quebec’s tax collection policies and questions its administrative practices, Justice Steve Reimnitz held that the provincial tax agency abused its powers, acted maliciously and in bad faith, and exhibited unjustified and blameworthy administrative doggedness in the way it handled the tax file of Groupe Enico Inc. and its founder Jean-Yves Archambault. The comprehensive 197-page ruling in Groupe Enico inc. c. Agence du revenu du Québec 2013 QCCS 5189 details a series of bizarre and improbable events, triggered by a dishonest auditor,  that has been likened by Quebec tax lawyers to an absurd “horror story” that “was bound to happen.”

“There have not been many decisions that have been rendered by the courts where Revenue Quebec has been sued for damages,” pointed out Alexandre Dufresne, a Montreal tax lawyer and managing partner of Spiegel Sohmer. “Not only that, Revenue Quebec lost and the damages were very substantial so in that sense it is a very important decision. The judgment outlines what I would call a horror story – it really was an abusive audit.”

The Enico ruling, coupled with another ruling issued in mid-October by the Court of Quebec that also castigated Revenue Quebec for taking a far too aggressive stance against a family business, has prompted tax lawyers to question whether the provincial tax department has gone too far in its battle to fight tax evasion. When the Quebec government announced four years ago its intention to “return to a balanced budget by 2013-2014,” it increased the pressure on Revenue Quebec to recoup more monies. It is expected to recoup $3.9 billion in fiscal 2013-14, $600 million more than fiscal year 2012-13, and a significant increase over the $2.3 billion it was expected to recover in 2009-10, according to Revenue Quebec figures. The results have been mixed. Last year the taxman recovered nearly $3.5 billion, a sizeable increase over the $2.35 billion it reclaimed in fiscal year 2009-10. Indeed, Revenue Quebec boasts that for every dollar it invested it recouped $9.30 last year. But tax debts have surged as well, from $2.2 billion in 2010 to $7.6 billion last year. In short, as one tax lawyer put it, there is a huge gap between the amounts assessed and the amounts actually collected.

“Revenue Quebec employees are under a lot of pressure to recoup monies, and that leads to problems in the market,” noted Paul Ryan, a tax lawyer with Ravinsky Ryan Lemoine LLP in Montreal. “Ever since the provincial government introduced the return to a balanced budget program, the government is running Revenue Quebec like a business. I don’t know if it is appropriate for a tax department with all the powers they have in hand to be run like a business. But the attitude they have is that we fight everything; this time they got burnt.”

Yacine Agnaou, a Montreal tax lawyer who successfully plead the Enico case, concurs. “The Enico case is not unique; it is the accumulation of faults that makes it exceptional,” remarked Agnaou, who previously worked for the Canada Revenue Agency and the economic crimes team of the Public Prosecution Service of Canada. “We are currently facing in Quebec a tax authority that has put in place a tax collection system that crushes everything because the objectives set out by the government are too ambitious.”

Archambault’s Kafkaesque bureaucratic nightmare began when two tax department civil servants, one who incredulously posed as an intern even though he was an auditor with over 20 years of experience, paid him a visit to his company’s headquarters to examine his federal and provincial sales tax payments in 2007 after a former disgruntled employee who launched his own competing business denounced the company. When the tax department claimed he owed $325,000 in back taxes, Archambault testified that his life was “turned upside down.” Compounding the situation, the tax department held on to nearly $1 million in research and development tax credits Enico was counting on to carry on business and obtain further financing.

The situation then took a dramatic turn for the worse. Revenue Quebec lost track of a payment Enico made but nevertheless forwarded Enico’s tax file to its collection department, which quickly lead Enico to be considered delinquent. Other inexplicable and costly transgressions took place. Files and notes were either lost or intentionally destroyed. An auditor deliberately doubled the amount owed by Enico, leading to an erroneous notice of assessment.

“A notice of assessment, even one that is erroneous, is not a fault,” explained Justice Reimnitz. “The current case is very far from being a simple case of an erroneous assessment. We are speaking here about an assessment that was falsely inflated, and that was not corrected within a reasonable time even though they knew there were no grounds for these assessments. We are speaking here of assessments following intentional and malicious work. That is what is in question in this case.”

Matters got even worse. In February 2008, Revenue Quebec proceeded with two bank seizures, including the company’s line of credit, only to realize that it made an error and rescinded one of the seizures. But the damage was done. Enico’s bankers lost confidence, with one recalling its loan and credit line as well as refusing to make good on Enico’s paycheques. Employees then lost confidence in the firm, and many quit. Numerous clients and partners of the firm also ended their business relationship with the company.

The firm, which specialized in industrial automation and robotics, was healthy before the upheaval. Its revenues rose from $1.8 million in 2001 to $5.6 million in 2007. Following Revenue Quebec’s gaffes, it was forced to close shop in November 2010. When Enico filed for creditor protection, Revenue Quebec continued to hound the firm, going so far as to refuse an offer of 80 cents to the dollar unless Archambault dropped his lawsuit against the tax department – conduct that Justice Reimnitz described as symptomatic of the taxman’s conduct towards Enico and Archambault.

“Revenue Quebec argues that the applicants must demonstrate, both in respect to the assessment notices and the administrative seizure, that their representatives committed an intentional fault, acted in bad faith or abused its powers,” said Justice Reimnitz. “In the opinion of the Court, that is what was done. The applicants demonstrated serious carelessness, the equivalent of abuse of power. The reckless conduct by Revenue Quebec is the equivalent of bad faith, without regard to the predictable consequences that its conduct caused.”

Justice Reimnitz also reproached Revenue Quebec for failing to investigate the merits of the denunciation, particularly since it was the denunciation that drew the tax department’s attention to Enico and its founder. Evidence during the trial revealed that Revenue Quebec took no steps to determine whether the denunciation had valid grounds or whether it was done to cause harm. Nor did Revenue Quebec inform Archambault that the audit was spurred by a denunciation. “From this denunciation followed a decision to conduct an audit, which was not revealed to the taxpayer,” noted Justice Reimnitz. “The fact that Revenue Quebec dealt with the denunciation without examining the interests of the whistleblower and approached the taxpayer without informing him of the existence of the denunciation and of the real goal behind the audit leaves the Court perplexed with regards to the respect of the taxpayer’s rights to obtain a full and complete defence during the auditing process.”

Justice Reimnitz also examined a practice that to this day Revenue Quebec vehemently denies exists – a quota system that rewards auditors. “We categorically deny that there is a quota system in place,” said the tax department’s spokesperson Stéphane Dion. Justice Reimnitz however found that objectives are dictated by the government, and that the objectives are dispatched to different departments within Revenue Quebec. Each department has a fixed amount to recuperate. Auditors who fulfill objectives stand to earn between $1,000 and $1,200. Employees who perform exceptionally can be rewarded with a 3.5 per cent bonus, based on their salary.

“The principle is clear,” remarked Justice Reimnitz. “If one compensates a civil servant for the amounts that he recuperates, it will incite him to recover more, with the risk that it can bias his judgment when doing his auditing work. His interest is evident. That is all the more serious since the auditor is also a decision-maker. The role of a decision-maker and the role of an auditor are in the opinion of the Court incompatible with the notion of objectives or quotas. A decision-maker cannot have an interest in a decision he makes. That seems to be common sense.”

But that logic seems to escape the provincial tax authority, said Agnaou. “It is such an unhealthy pressure to place in the hands of a civil servant who has so much power and to tell him that if he doesn’t generate a product, it will have a negative impact on his professional career,” noted Agnaou. “Revenue Quebec doesn’t understand all the pain they can cause with their power.”

Etienne Gadbois, a tax lawyer with Montreal law firm De Grandé Chait LLP , is hoping that the ruling will lead Revenue Quebec to adopt some changes in the way it deals with taxpayers. “It’s going to be interesting to see if the relationships between taxpayers and Revenue Quebec at the collection level, audit level and objection level will change in light of these cases,” said Gadbois. “But I don’t think we will see a drastic change tomorrow. It is a big agency.”


PUNITIVE DAMAGES AGAINST REVENU QUÉBEC

On  October 23,  2013, an  unprecedented judgment of  the  Cour superiéure du  Québec (QCCS) in Groupe Enico (2013 QCCS 5189) granted some $4 million in  damages to  two  taxpayers that  underwent an abusive audit. The  court found that  Revenu Québec abused its power and  conducted its audit,  reassessments, and  collection measures in bad  faith. The  damages compensate for  the  failure of the  targeted business and  include $2 million in punitive damages. Tax  authorities continue to bolster their auditing and   collection activities, but  this  judgment may sound an  alarm concerning abusive practices in any  dealing with a taxpayer, from audit to collection.
Increasingly, taxpayers have questioned the  behaviour of  both the  CRA and  Revenu Québec. In determining an  assessment’s validity, a court generally does not  consider allegations of  the  tax  authority’s misbehaviour. In Ereiser (2013 FCA 20),  the  FCA clarified the  avenues available to a taxpayer—a civil  claim for  damages against the  CRA or Revenu Québec before the  FC  or a provincial superior  court, or, in certain extraordinary situations, judicial review.
The  Groupe Enico decision comprises about 200  pages of  facts and  analysis and  is one  of  only a
few  to find  negligence on  the  part  of a tax  authority in administering and  enforcing a tax  statute. The finding was based on  fault and  responsibility to third parties under Quebec civil  law, not  on  the  common law duty of care.
The  corporate taxpayer, Groupe Enico, was established in  1990 and  ceased activities in  November  2010. In  October 2005, Revenu Québec initiated a GST and  QST audit after receiving a  letter, which it later destroyed, from a disgruntled former employee. The  GST/QST auditor went to  the  taxpayer’s office with a  so-called intern—an income tax  auditor with over 21  years’ experience and  a prior record of  misbehaviour. The  taxpayer became aware of  the  parallel income tax  audit only in May 2007, when proposed reassessments were issued.
On  October 15,  2007, a  first  notice of  reassessment was issued for  additional tax,  interest, and penalties of more than $450,000. Surprisingly, two  weeks later a Revenu Québec internal memo said that  the  undeclared income was actually $50,000. The  discrepancy arose from double entries in the taxpayer’s records, which created more than $200,000 of expenses denied on  reassessment. Revenu  Québec contended that   the  “false and   fictitious entries” emerged when GST and   QST records were reconciled with income tax  records, but  the  court found that  the  Revenu Québec auditor had created the  entries intentionally and  in  such a manner as  to  avoid detection.

The  court said that  an erroneous reassessment does not  by  itself constitute fault. However, Revenu Québec was clearly aware very early on  that  the  reassessment was inflated; nonetheless, it took more than nine months to  adjust it.  The  court concluded that  the  reassessment was the  result of  malicious and  intentional behaviour.
Further unremedied mistakes followed. In February 2008, Revenu Québec’s collection department used the  administrative seizure process to  seize the  taxpayer’s line of credit even though it  had known since October 2007 that  the  tax  bill  would be significantly reduced. The  bank then recalled the
$600,000 line of credit: unpaid salaries caused employees to resign and  concerned clients and  suppliers to flee and a precarious cash flow situation developed.
Previously, Groupe Enico had been profitable and  was expanding, but  it ceased operations in November 2010. Revenu Québec representatives unsuccessfully attempted to leverage insolvency pro- ceedings to force the  taxpayer to drop all claims against it, and  it employed numerous delay tactics in the  civil  lawsuit. Revenu Québec deliberately destroyed documents and  chose not  to  call  the  main auditor as  a  witness: the  taxpayer had  to  hire  a  private investigator to  track him  down. The  court found that  Revenu Québec’s objective was to  exhaust the  taxpayer financially and  to  prevent a trial on  the  merits, and  that  Revenu Québec engaged in wilful misconduct, bad  faith, and  abuse of power in dealing with the  taxpayer. The  taxpayer successfully demonstrated that  Revenu Québec’s conduct was grossly negligent and  reckless as to predictable consequences.
The   Revenu Québec income tax  auditor’s testimony confirmed what Revenu Québec had  hotly denied: auditors have quotas—in this  case, $1,000 of  recovery per  hour—linked to  a bonus (up  to
3.5  percent of total pay) for  exceptional performance
. The  Revenu Québec collection department also admitted that  a quota was imposed on  its  agents, but  it did  not  specify rates. The  court linked the quota to the  reprehensible conduct: Revenu Québec auditors and  decision makers were not  disinterested law  enforcers but  interested parties.
Although the  files of  the  GST/QST auditor and  the  income tax  auditor were destroyed, many internal  Revenu Québec communications were disclosed at  trial and  helped demonstrate that   Revenu Québec agents knew early in  the  process that  the  reassessments were falsely and  greatly inflated. The  decision is likely to affect the  recordkeeping habits of Revenu Québec officials and  perhaps other  Canadian tax  authorities who no  doubt are  closely following the  civil  suit. A  recent report of  the Office of  the  Information Commissioner of  Canada notes an  increased number of  complaints under the  Access to  Information Act  about the  lack of  CRA disclosure in  access to information requests, requests that  undoubtedly yielded the  information essential to  support the  damage claim in  Groupe Enico.
A taxpayer who undergoes an abusive audit faces a challenging environment. An  assessment may be  challenged in  the  TCC federally or  in  the  Cour du  Québec provincially, but  judicial review is  only available in  the  FC  for  federal matters and  in  the  QCCS for  provincial matters. Different courts have jurisdiction over an  action in damages. The Federal Court  or QCCS for  federal matters and  the  QCCS for  provincial  matters. It is also unclear when the  limitation period begins to run  in this  context: is it triggered by the  audit, by  disclosure of  information that  the  audit is abusive, by  improper collection measures, or by the  quashing of the  reassessment?
The  Cour du  Québec upheld some assessments against the  taxpayer, apparently ex  parte, because Groupe Enico did  not  have the  financial resources to contest the  assessments while the  action in damages proceeded. However, the  QCCS’s decision in Groupe Enico may signal that  some claims against tax  authorities will  be successful.
The  court granted about $1.1 million in  damages to  the  company’s founder and  shareholder (including $1 million in  punitive damages) and  $2.75 million to  Groupe Enico (also including $1 million in punitive damages and  $350,000 for  legal costs). The  unprecedented $2 million punitive damages award against a public body was grounded in the  Quebec Charter of Human Rights and  Freedoms, which allows punitive damages for  “unlawful and  intentional interference” (including reckless disregard) with various rights, including the  peaceful enjoyment of property. Under the  Civil Code of Québec, punitive damages “may not  exceed what is  sufficient to  fulfil their preventive purpose,” but  the court in  Groupe Enico said that  a  serious deterrent was required because, inter alia, a  public body should exemplify a high standard of conduct and  because many meritorious claimants probably never make it to trial.
The  facts in  Groupe Enico were particularly egregious, and  the  courts will  have to  navigate cases
involving facts that  are  not  so  clearcut. Proving wilful misconduct, bad  faith, or  abuse of  power will remain a challenge, but  taxpayers now have a strong precedent.
On  November 22,  2013, Revenu Québec filed documents with the  Cour d’appel du  Québec, but the  extreme facts make it unlikely that  the  finding of liability will  be overturned. Even if the  quantum is reduced, the  trial  court’s judgment is likely to be generally confirmed. If the  appeal proceeds, it will  be several months before a hearing takes place. Similar cases are  proceeding to trial  in other provinces, and  taxpayers and  tax  authorities are  no doubt watching their progress carefully.