Taxpayer Misconduct and the Deductibility of Damages

Can a taxpayer's misconduct be a factor to consider when determining the deductibility of a payment for damages? On the basis of the FCA's comments in Canadian Imperial Bank of Commerce v. Canada (2013 FCA 122), the answer appears to be no.

In 2005, the Canadian Imperial Bank of Commerce (CIBC) was named as a defendant in two lawsuits in the United States totalling several billion dollars. The bank was sued, jointly and severally with other co-defendants, by shareholders of a US company, Enron, who lost significant sums when it went bankrupt. The plaintiffs claimed in particular that the CIBC was blind to Enron's violation of US accounting standards in transactions financed by the CIBC. They argued that the bank acted thus to earn fees and to ensure financial dealings with Enron in the future. The CIBC settled the lawsuits by paying almost $3 billion in an out-of-court settlement.

The CIBC deducted the amounts paid under the settlement pursuant to paragraph 18(1)(a) of the Act. The CRA issued the CIBC a series of notices of reassessments in which it disallowed the deduction for the amounts paid. The CIBC challenged all of these notices.

At trial, the TCC dismissed in part the CIBC's interlocutory motion to strike allegations contained in the CRA's reply to the notice of appeal. The CRA allegations that the TCC refused to strike mentioned that the CIBC's misconduct in the Enron file had been so "egregious and repulsive" that any consequential settlement payments could not be justified as having been incurred for the purpose of gaining or producing income from the business within the meaning of paragraph 18(1)(a). The FCA had to decide whether the TCC's judgment on the interlocutory motion was well founded.

The CIBC submitted that the CRA's argument had no legal basis.

The CRA replied that its position was based on the comments of Iacobucci J in 65302 British Columbia Ltd. v. Canada ([1999] 3 SCR 804) on the deductibility of penalties paid for the purpose of gaining or producing income from a business. In obiter, Iacobucci J mentioned that it is possible to imagine a breach so "egregious or repulsive" that any subsequent penalty could not be considered to have been incurred for the purpose of gaining or producing income. These comments have already been applied by the courts--in particular, when analyzing the deductibility of damages (for example, in McNeill v. The Queen, 2000 DTC 6211 (FCA)).

The FCA agreed with the CIBC's submissions and reversed the judgment, dismissing the motion to strike. In its reasons, the court explained that there was no provision in the Act stipulating that a taxpayer's misconduct prevents amounts from being deducted under paragraph 18(1)(a). The court added that the CRA clearly misinterpreted the comments of Iacobucci J in 65302 British Columbia, since the judge had even taken care to specify that it was for Parliament to legislate if it wanted the Act to consider a taxpayer's misconduct when determining the deductibility of a payment.

Francis Hally
Dentons Canada LLP, Montreal

Canadian Tax Focus
Volume 3, Number 4, November 2013
©2013, Canadian Tax Foundation