If your tax plan goes awry, maybe your adviser ends up footing the CRA bill

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Allan Lanthier is a retired partner of an international accounting firm and has been an adviser to both the Department of Finance and the Canada Revenue Agency.

Recently, the Quebec Superior Court found that Big Four accounting firm KPMG committed professional misconduct by not properly advising its client of the risk involved in a tax plan. The court awarded the client about $3.9-million: the tax and interest owing when the plan failed.

Advisers who market aggressive tax plans have been put on notice. The March 6 court decision is a stark warning that, unless risks are clearly set out when providing tax advice, the adviser may bear the consequences.

The company in question, Gennium, is a Canadian corporation involved in generic drug distribution, owned by entrepreneur Louis Pilon and by a trust for the Pilon family. Mr. Pilon wanted to use the company’s profits to expand into drug manufacturing. But drugs can be a risky business – lawsuits are common – and he wanted to protect his assets by using separate corporations for the two businesses.

While there were some fairly simple ways to achieve asset protection – in fact, the family trust had been created partly for this purpose – KPMG presented a different plan to Mr. Pilon in 2005 that also offered potential tax benefits.

A new trust was created, and, after a complex series of transactions, Gennium’s cash was paid as dividends to the new trust from 2005 to 2007. The relevant Canadian tax rules were black and white: There was no tax to Mr. Pilon or the new trust, and the trust invested all of the cash in new corporations for the drug manufacturing business.

And here’s the best part: Years from now, when Mr. Pilon wanted to take assets from the new trust for personal use, there would be no tax either.

There was only one problem: Canada’s general anti-avoidance rule. Under the GAAR, the Canada Revenue Agency can recharacterize the tax results if a plan is “abusive,” unless it is put in place primarily for non-tax purposes.

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KPMG’s own internal “GAAR committee” had reviewed the plan and concluded that, unless there was a primary non-tax purpose such as asset protection, the CRA would likely prevail in the event of a dispute, and the dividends would be taxed at personal tax rates.

However, Mr. Pilon was never advised of the committee’s conclusion. The CRA issued assessments taxing the dividends received by the new trust, and Mr. Pilon went to tax court. The government prevailed, and Mr. Pilon sued KPMG for the taxes and interest he had suffered.

In finding against KPMG, the Quebec Superior Court came to a number of conclusions.

KPMG’s view was that the primary purpose of the plan was asset protection and that the GAAR should therefore not apply. But what if the CRA disagreed? After all, Mr. Pilon already had a family trust protecting his assets. The court said that KPMG had an obligation to discuss the risk with Mr. Pilon. It did not: Rather, there was at best only a general discussion of the GAAR supported by a PowerPoint presentation.

The court also said that taxation is constantly evolving, and that KPMG had a duty to keep Mr. Pilon advised of developments after any initial advice was given and the plan was in place – something KPMG failed to do. For example, the CRA issued an interpretation letter in 2006 stating that the use of a trust similar to that involved in the KPMG plan could result in the application of the GAAR. KPMG never advised Mr. Pilon of this new CRA position.

This conclusion will be of concern to many tax advisers. While KPMG remained the tax adviser to Mr. Pilon in 2006 and subsequent years, what would the court have concluded had it not? Is there also a duty to advise former clients of new developments, and, if so, when does that duty end?

Finally, did Mr. Pilon suffer damages, or would he have had to pay the $3.9-million anyway? There were damages, the court said, because were it not for the KPMG plan, all cash would have remained in Mr. Pilon’s corporate group to fund new acquisitions.