In Addison & Leyen Ltd v Fraser Milner Casgrain LLP, 2014 ABCA 230, the Alberta Court of Appeal confirmed that tax advisors do not owe a common law duty of contribution and indemnity to recipients of their tax advice when that advice turns out to be wrong.
The appellant company and its former directors and/or shareholders were owners and/or directors of a Saskatchewan company (York). York sold its assets in 1988. The only asset remaining was $2.8 million in cash, which was retained to pay its estimated income tax liability for the 1989 taxation year.
In September 1989, the appellants sold their shares in York and resigned as directors. At the time, they were not aware that the purchaser intended to use the available cash to buy seismic data, which it believed would allow it to claim a tax deduction to offset York’s remaining income tax liability for the 1989 taxation year.
As a condition of closing the share purchase transaction, the purchaser was required to provide a legal opinion to the appellants concerning their potential tax liability as former directors and/or shareholders of the company. This legal opinion was provided by the respondents, who advised that York would be able to pay its income tax liabilities and the appellants would not be liable for any taxes.
In 1992, the company was reassessed for the 1989 taxation year in the amount of $3,247,074, including penalties and interest, based on the purchaser’s over-valuation of the seismic data it had acquired. As a result, the seismic data did not offset York’s remaining tax liability for 1989.
The purchaser was ultimately unable to pay the reassessed taxes on behalf of York, so in 2001, the Minister issued notices of assessment to the appellants pursuant to section 160 of the Income Tax Act(ITA), taking the position that the appellants were liable for York’s income tax debt up to the amount that each of the appellants had received from York.
In October 2010, the appellants and the Minister entered into a settlement agreement, whereby York was left with a reduced tax liability of $492,676, which was paid by the appellant, Addison & Leyen Ltd.
The appellants commenced the action against the respondent tax advisors seeking $1.75 million. However, the appellants’ claim in negligence was made outside of the 10-year ultimate limitation period and was thus barred. As a result, the action was based on an implied contract of indemnity only.
The issue before the Court was a limited one – could the appellants’ advance a claim of contribution and indemnity against its tax advisors? If the answer was yes, then the claim could continue. If they were limited to a claim in negligence, however, the claim was statute-barred and the action would be at an end.
After reviewing the applicable authorities, the Court concluded that the respondents did not owe a common law duty to indemnify the appellants.
The Court noted that a claim for indemnity is a claim that another party save the indemnity-claimant harmless against loss or damage that the indemnity-claimant has incurred or suffered, or will incur or suffer, at the hands of another, and to reimburse the claimant in respect of such loss or damage. While on the surface the scope of the obligation to indemnify would seem to capture the present case (the appellants incurred losses at the hands of their tax advisors), the circumstances under which an indemnity will be found to exist are fairly circumscribed. The claim may arise from an express contract, by implication of law or from statute.
The Court agreed with the trial judge that the appellants’ claim did not fall within the circumstances necessary to imply a promise to indemnify, largely because the party against whom the indemnity was sought could not have been legally responsible for York’s (and thus the appellants’) tax liability. Given the respondents’ alleged negligence only caused damage to the appellants and not the Minister, the appropriate cause of action was negligence alone.
The Court rejected the appellant’s submission that a common law right of indemnity should be available in any case where a party, without fault of its own, is exposed to liability or loss for the wrongful act of another. The principles of indemnity are rooted in restitution and unjust enrichment, which imply that the wrongdoer gained something unlawfully. Consequently, an indemnity permits the reimbursement of damages paid by an innocent party to a third party on behalf of the true wrongdoer, where that wrongdoer would otherwise have been liable to pay. In this sense, the wrongdoer has gained by having someone else compensate the third party for the wrongdoing. A right to reimbursement through an implied indemnity does not arise in every situation in which one party becomes liable to a third party due to the negligence of another. Rather, an indemnity requires that both parties owe legal liabilities to the third party, i.e., when the party against whom the indemnity is sought could have been liable to the third party for all or part of the claim.
In this case, the amounts paid by the appellants to the Minister, and their associated expenses, were never amounts paid by the appellants on behalf of the respondents as the wrongdoer. The respondents were not, and could not, be liable to the Minister for any part of York’s tax liability. Thus, there is no basis on which to require restitution of the appellants’ loss through an implied indemnity.
The Court also confirmed that a duty to indemnify requires a connection between the wrongdoer, the third party and the damage. In this case, there was no connection between the respondents, the Minister, and the tax liability.
The appellants suffered losses as a result of relying on the respondents’ tax opinion, but any negligence in preparing that opinion had no impact on the Minister as a third party to which the tax liability was owed. The liability flowed from the Minister’s assessment of the appellants for York’s outstanding tax liability and the appellants’ obligations under the ITA.
The Court also held that the policy implications of such an extension of the common law are significant. Anyone who gives advice could be considered to provide an implied indemnity to their clients, covering any loss incurred in relying on that advice and could subject professionals to indeterminate litigation under a never-ending limitations period.
While the result of the decision seems unfair, it is a principled decision that respects the common law. An indemnity is meant to compensate those who have incurred a loss or damages that are rightfully to the account of another. In this case, the appellants arguably could have asserted a right of indemnity against York, as it was York that incurred the tax debt and remained liable to the Minister for that debt. An act of negligence unconnected to that debt, even if it arguably caused loss to the indemnity seeker, cannot be sufficient to create an implied indemnity. The negligence must be such that it renders the wrongdoer directly liable for the initial debt. In this case, the respondents’ alleged negligence could not render it liable for the tax debt owing to the Minister. Ultimately, this case serves as a reminder that obtaining contractual indemnities where possible is advisable.