Tax-motivated donation schemes have been in the public eye for decades now.
Such schemes have long been on the radar of the Canada Revenue Agency, since before it was CRA or even CCRA, back to when it was Revenue Canada. In progressively more formal pronouncements and definitive tones, the agency has warned about the tax exposure risks of engaging in such enterprise.
In recent years, CRA has actively – and very effectively through the tracking convenience of assigned tax registration numbers – pursued and reassessed participants. Purported tax benefits have been reversed, interest layered on, and penalties imposed.
A degree removed from the taxpayer-agency battles, it was inevitable that we would begin seeing civil cases before the courts. In particular, it is not at all surprising that affected investor-taxpayers would turn their attention toward those who assisted them in engaging in such programs.
The question remained whether and how liability might be determined. Some answers are now starting to emerge.
Wrangling with CRA
Just reported June 30, 2010 is an Ontario case in which an advisor was sued by his former client when CRA unwound claimed tax benefits.
For almost two decades, Accountant MP was a close advisor to client EL’s small business operations, and secondarily to EL himself and his wife VL. Mainly MP assisted with the business corporation’s financial and tax reporting, and also advised upon related personal tax matters, for example on decisions about dividend/salary mix. From time to time MP brought tax-related strategies to EL/VL, such as limited partnership units.
At issue in the case were artwork donation transactions MP recommended to EL in 1998, and to both EL/VL in 1999. A taxpayer could purchase prints in bulk for a little over $300 apiece, donate them to an American University at appraised values of 4-5 times the purchase price, and then submit the appraised value for calculating the charitable tax credit. In total over the two years, the couple ‘invested’ $78,500, claiming tax credits well in excess of that outlay, based on the later appraised values.
In 2001, EL/VL were reassessed, and initially faced both interest and penalties. When they consulted MP, he advised them not to pay the disputed amounts, and to await the outcome of a challenge the program sponsors intended to bring to court.
A test case did follow, spanning through to 2005 from the Tax Court to the Federal Court of Appeal and denial of leave to the Supreme Court of Canada. In the end, the tax credit was limited to the cost of the artwork, with no penalties due, but interest applied on the underpaid tax that was outstanding over the intervening years.
Client sues Advisor
Following this tax litigation, EL/VL, now into their retirement, became suspicious that MP may have been paid secret commissions on the artwork. A suit was launched against MP alleging breach of fiduciary duty, or in the alternative negligence.
While characterization of a “fiduciary” is most familiar in trustee-beneficiary and principal-agent relationships, it is not unknown to be impressed upon other relationships where there is a strong degree of reliance upon another person. In fact, in 1994 the Supreme Court of Canada found a tax accountant to be a fiduciary to a stockbroker.
In the present case, the judge had “no hesitation in concluding that, in relation to matters of tax planning, [MP] had undertaken to act solely on behalf of [EL/VL] and had relinquished his own self-interest in that regard, except for the normal fees he would charge for providing his advice.”
The judge’s factual determinations included:
Obtaining a secret commission, and worse that it was paid by the scheme’s promoters
Failure to point out the risks identified in the promoter’s own legal opinions, and worse still … failure to even disclose the existence of the legal opinions being in MP’s possession
Pressure tactics employed by MP, including tight time constraints and pre-completion of purchase orders by MP prior to arriving at meetings with EL
Quantifying the damages
The direct cost of the endeavour was the $78,500 outlay less $38,703 taxes avoided, netting to $39,797. In addition, EL/VL sought the $7,500 commission to MP, interest payable to CRA on the outstanding taxes, and interest on money borrowed to ultimately pay the bill – a total claim of $151,500.
While the two interest charges were not accepted as appropriate heads for compensation, the judge otherwise dispensed with any notion that the claim should be reduced because EL/VL could have acted differently. MP was held liable for the net taxes and also had to pay over the commission to EL/VL.
Perhaps the egregious elements of this case make the outcome easy to understand, but the finding should ring loudly for all advisors touched by such schemes.
It remains a fact-dependent determination whether advisors of other stripes and levels of interaction may be characterized as fiduciaries, and what quantum of liability may ensue. That’s a lot of grey area yet to be explored.