The Ontario Superior Court of Justice recently awarded approximately $45,000 to two individuals who sued their accountant for advising them to participate in a donation tax shelter arrangement and for taking secret commissions in respect of the scheme. The donors were reassessed by CRA and successfully sued their accountant for the losses they incurred as a result of their participation.
In Lemberg v. Perris, the plaintiffs were a retired couple who had relied on the defendant, a chartered accountant, for many years to provide tax advice concerning both their personal taxes and those of a small business of which they were the sole shareholders. In 1998 and 1999, the accountant advised the plaintiffs about a donation arrangement offered by a promoter whereby the donors would purchase in bulk certain limited edition artwork (at a substantial discount) which would then be sold for many times the purchase price to educational institutions in the U.S. The donors would receive a tax credit on the market value of the property.
According to the decision, the accountant strongly encouraged the plaintiffs to participate. In 1998, the plaintiff husband agreed and paid $31,000 for artwork which was then donated to a U.S. University (a Canadian qualified donee). The University recorded a donation of $136,500, and the plaintiff claimed a tax credit in that amount. Both plaintiffs participated in 1999, this time purchasing artwork for $47,500 and subsequently donating it for a tax credit well in excess of this amount.
In 2001, the plaintiffs were reassessed by CRA, with their tax credits ultimately being limited to the amount actually paid for the artwork. CRA waived penalties, although interest was charged on the tax debt. The Court noted that, in the final analysis, the plaintiffs ended up paying $78,500 for artwork which they would never have purchased had they not participated in the program. Subtracting the tax credits legitimately claimed, the plaintiffs were worse off by $39,795 as a result of their participation in the program. In addition, however, they also paid approximately $75,000 in interest on their tax underpayments, and were required to borrow money to pay back the taxes, which incurred an additional $29,000 in interest on the borrowed funds. It was also learned that the accountant had received an undisclosed commission on the transactions, amounting to approximately $7,500. The plaintiffs sued for the total of these losses, $151,500.
The Court found that in the circumstances of the case, the accountant was in a fiduciary relationship with the plaintiffs due to the long-standing nature of their business relationship and the mutual trust which had developed. The Court stated that it had no doubt that the accountant had breached his fiduciary obligations. The most fundamental breach of his fiduciary obligations occurred when the accountant took secret commissions on the sale of artwork from the promoter of the tax shelter arrangement. The Court also noted that the accountant paid scant attention to the warning signs that should have alerted him to the risks he was suggesting his clients undertake. As a seasoned tax practitioner, the accountant was expected to have understood that the legal opinions provided were not guaranteeing the consequences of the transactions but were based on particular facts.
The Court held that the plaintiffs were entitled to their basic loss of $39,795. They were also entitled to $7,500 to disgorge the secret commissions earned by the accountant. The Court held that because the plaintiffs had access to their funds until they were required to repay it, they were not entitled to interest.
This case serves as a cautionary tale to individuals considering participation in a donation tax shelter arrangement and advisors suggesting such participation to their clients. Certainly advisors should never accept fees without first fully disclosing they are doing so. As we have stated in previous editions of this Newsletter, CRA has said it will audit all donation tax shelter arrangements with a view both to reassessing donors and, in many cases, to revoking the charitable registration of charities that may have participated. The case also indicates the breadth of liability which flows from tax shelter arrangements determined by CRA and the Courts to be abusive. The importance of independent legal advice before participating in such arrangements, or before advising others to participate, cannot be overstated.