COURT CASES
Company wins $4,000,000
in Punitive Damages against CRA – Quebec
CRA’s abusive audit and bad faith
Tax Authority’s Misbehaviour
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 Québec2013 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 whistleblowerand 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
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.
