Citation: 2009 TCC 293
RUSSELL W. LAVOIE,
HER MAJESTY THE QUEEN,
REASONS FOR JUDGMENT
 This appeal is brought by Mr. Lavoie under the
informal procedure from an assessment whereby the Minister of National Revenue
has added $303.00 to his income for the 2005 taxation year. This is the
aggregate of three amounts that were paid to him pursuant to two settlement
agreements reached between the Ontario Securities Commission (OSC) and two
corporations engaged in the business of managing mutual funds (the fund
managers). The case is significant not only to Mr. Lavoie, but also to a
large number of other taxpayers who received payments as a result of these
agreements because they held units of the mutual funds managed by the fund
managers (the managed funds) within their registered retirement savings plans
 The appeal came on
for hearing in Hamilton, Ontario before another judge of this Court who, after hearing
the evidence, concluded that he should recuse himself. The facts of the case
are not in dispute, so the parties agreed that a different judge should hear
their submissions and then give judgment based on the transcript of the
evidence of the appellant, who was the only witness, the exhibits, and the
Partial Statement of Agreed Facts filed by the parties at the first hearing.
After reading the transcript, the exhibits and the agreed facts, I heard
argument in Toronto on February 9, 2009. The decision of the Federal
Court of Appeal in Tesainer v. the Queen
was delivered on February 10, 2009. I invited counsel to make additional
submissions in writing concerning that decision, which they both did.
 The following are the
facts that were agreed to by the parties.
1. Mr. Russell Lavoie (the “Appellant) is a resident of Waterloo,
2. The Appellant is the annuitant of a Registered Retirement
Savings Plan (“RRSP”) under an arrangement with Manulife Securities
3. The RRSP owns units in various mutual fund trusts,
including units in Franklin Templeton Mutual Funds (“Franklin Templeton”) and
AIC Mutual Funds (“AIC”), (collectively referred to as the “Fund Companies”).
4. AIC is a fund manager responsible for the management of
approximately 47 mutual funds with over $8 billion of assets.
5. Similarly, Franklin Templeton is a mutual fund dealer and
advisor, and is responsible for the management of approximately 90 mutual fund
assets worth of approximately $18.6 billion.
6. Franklin Templeton and AIC were among the American mutual
fund companies that, in the year 2003, were investigated in the United States
for abusive trading practices, specifically late market timing trades.
7. Following the investigations in the United States, the
Ontario Securities Commission (the “Commission”) initiated a similar
investigation in Ontario.
8. Specifically, in November 2003, the Commission, in
cooperation with the Investment Dealers’ Association of Canada and the Mutual
Fund Dealers’ Association of Canada, began an inquiry into potential late
trading and market timing activities in the Canadian mutual fund industry.
9. Following the investigations in Canada, the Commission
concluded that AIC and Franklin Templeton were among a number of companies that
failed to protect the best interests of their funds. Furthermore, the
Commission concluded that the Fund Companies acted contrary to the public’s
interests by neglecting to implement appropriate measures to protect their
mutual funds against the harm associated with frequent trading market timing
10. The Commission reached settlements with five mutual fund
companies, two of which were AIC and Franklin Templeton. AIC and Franklin
Templeton reached settlements with the Commission in December 2004 and March
11. As part of the settlements reached by Fund Companies and the
Commission, it was agreed that provided the Fund Companies honored the terms of
their settlement, the Commission would not initiate any proceedings against the
Fund Companies for violations of Ontario’s Securities Act.
12. On December 6, 2004, AIC agreed to make a payment in the
amount of $58.8 million to the unit-holders of its mutual funds who suffered
harm from the market timing activities of the company (the “Affected
13. In February 2005, Franklin Templeton agreed to make a
payment in the amount of $49.1 million to the Affected Investors of its
14. The five mutual fund companies with whom the Commission had
reached a settlement agreed to prepare a plan for distributing the Funds (“Plans
of Distribution”), the objective of which was to provide a fair allocation of
the funds among the Affected Investors in a timely manner and in a way in which
the costs would be reasonable in the circumstances.
15. On June 30, 2005, the Commission approved the Plans of
Distribution that required the five Canadian mutual fund companies to disburse
$205.6 million to their Affected Investors.
Plans of Distribution for AIC and Franklin Templeton provide:
Some of the
payments under the Plan will be payable to tax‑deferred registered plans
(such as registered retirement savings plans,) registered retirement income
funds or registered educational savings plans). The Company will make payments
in respect of such plans to the annuitant or beneficial owner of such plans as
opposed to the plan itself.
17. The Fund Companies did, in fact, make such payments directly
to the RRSP annuitants. One of these annuitants was Mr. Lavoie.
18. In or about September 2005, Mr. Lavoie received three cheques
from the two Fund Companies totaling approximately $313.00 (the “Payments”)
19. The Payments represented Mr. Lavoie’s portion of the
settlement proceeds which were required to be distributed by the Fund Companies
pursuant to their settlement agreements with the Commission and the Plan of
20. In the letters accompanying the Payments from AIC and
Franklin Templeton were identical in content. Each letter stated:
On June 30,
2005, the Ontario Securities Commission approved the Plans for the distribution
by five mutual fund companies of amounts that those companies agreed to
distribute for the benefit of “affected investors” under settlements relating
to “frequent trading market timing”. The Plans (which were prepared under the
oversight of an independent consultant and have been approved by Staff and the
Chair and a Vice-Chair of the Commission) can be found on the Commission’s
website at www.osc.gov.on.ca.
* a cheque
representing the payment to which you are entitled under [Franklin Templeton
Investments’ Plan / AIC Limited’s Plan] in respect of all your affected fund
investments held in any of your [Franklin Templeton / AIC Limited] accounts,
* a breakdown
of your payment that sets out the accounts affected, the funds held by you in
respect of which the payment is made and the amount of any tax withheld, and
* a guide that
outlines the general tax implications of this payment.
that under the terms of the Plan, your right to this payment will expire on
June 1, 2008 if you have not cashed the cheque by that date. Amounts
represented by cheques that are not cashed by that time will be paid to the
with each letter was a Payment Statement setting out:
name of the mutual fund
account type in which the mutual fund was held
dealer account number
gross amount of the payment
amount of withholding tax withheld (if any), and
net amount of the payment, and then
amount of the cheque
22. The Franklin Templeton Investments Payment Statement also
included the statement:
the statement for income tax purposes. No other tax statement or tax slip will
be provided to you.”
AIC Payment Statement included the statement:
this Payment Statement and the attached Tax Guide for tax purposes. No other tax
statement or slip will be provided to you with the exception of DPSP and
registered pension plan accounts.”
24. The Tax and Information Guide that was also included stated,
in part, as follows:
This is a
general guide that is intended to help you determine the Canadian income tax
treatment of the enclosed payment and to answer some other questions you might
have. This is not legal or tax advice and may not address your particular
situation. Therefore, you are advised to consult your own tax advisor with
respect to your own situation.
Statement is enclosed with this guide. The Payment Statement itemizes by
account: the amounts paid to you, the investments to which each amount relates
and the taxes withheld, if any.
need the information on the Payment Statement to determine the proper tax
treatment of the amounts received by you. No other tax statement or tax slip
will be provided to you, with the exception of DPSP and registered pension
INCOME TAX TREATMENT OF PAYMENTS TO CANADIAN RESIDENTS
held in an RRSP or RRIP.
A payment in relation
to an investment held in your RRSP, LIRA, locked-in RRSP, RRIF, LIF or LRIF is
included in income in the taxation year that included the date of payment is
received in the same way that is a withdrawal from your registered plan is
included in income. If the payment is $200 or more, taxes have been withheld.
If your spouse
made contributions to your plan in any of the 3 years preceding the year in
which you receive the payment, this payment will generally be taxable to your
spouse instead of you.
receipt of the cheques or soon thereafter, Mr. Lavoie cashed them.
26. In filing his 2005 personal income tax & benefit return,
Mr. Lavoie did not include the Payments in his income for tax purposes.
27. May 1, 2006, the CRA assessed Mr. Lavoie’s 2005 income taxes
as filed by Mr. Lavoie.
28. In or about February 2007, Mr. Lavoie received a Notice of
Reassessment dated January 29, 2007 from the CRA in which the Minister of
National Revenue (the “Respondent”) reassessed Mr. Lavoie’s tax liability for
the 2005 taxation year by including the Payments as taxable income.
29. On or about March 31, 2007, Mr. Lavoie filed a Notice of
Objection to the Minister’s reassessment.
30. On July 18, 2007, the Minister confirmed his reassessment on
the basis that the Payments represented a benefit out of or under an RRSP, and
therefore, according to the Minister, Mr. Lavoie was required to include the
Payments in his income pursuant to paragraph 56(1)(h) and subsection 146(8)
of the Income Tax Act (the “Act”).
 Exhibit A-3 at the trial is the Statement of Claim in
a class action begun in the Ontario Superior Court on behalf of, among others,
the unitholders in the managed funds against Franklin Templeton, AIC, and other
fund managers claiming, among other relief, damages arising out of the market
timing trading transactions.
 The appellant’s
position is that the payments do not come within section 3 of the Income Tax
(the Act); they are a windfall, and so not subject to taxation. In this
he relies on the decision of the Federal Court of Appeal in The Queen v.
and on Interpretation Bulletin IT-334R2, which expresses the assessing policy
of the Minister of National Revenue in respect of the receipt by taxpayers of
gifts and windfall amounts. The bulletin in large measure adopts the seven
factors that the Court of Appeal in Cranswick found to be relevant in
identifying a non‑taxable windfall.
 The respondent’s
position is that the payments do not meet the test for windfall amounts, but
are amounts paid in compensation for the harm caused to the appellant’s fund
holdings in his RRSPs by the market timing transactions that were sanctioned by
the fund managers, AIC and Franklin Templeton. The respondent makes two
arguments that flow from this. First, Mr. Bartleman argues that on a proper
analysis the Cranswick factors do not lead to the conclusion that these
payments should be characterized as windfalls. Second, he argues that the surrogatum
principle applies, and that it has the effect of characterizing the payments as
amounts received by the appellant out of or under his RRSP, and therefore to be
included in his income by reason of subsection 146(8) of the Act. That
146(8) There shall be included in
computing a taxpayer’s income for a taxation year the total of all amounts
received by the taxpayer in the year as benefits out of or under registered
retirement savings plans, other than excluded withdrawals (as defined in
subsection 146.01(1) or 146.02(1)) of the taxpayer and amounts that are
included under paragraph (12)(b) in computing
the taxpayer’s income.
 In Cranswick,
the payment in question was made gratuitously by the majority shareholder and US parent
company of a Canadian corporation to a minority shareholder. The parent had
caused the corporation to sell part of its business at a price substantially
below book value, and subsequently it offered to purchase the shares of the minority
shareholders, or alternatively to pay them $3.35 per share. The offer was made
“… in the hope
of avoiding controversy or potential litigation on behalf of minority
shareholders …”, but not “… by reason of any enforceable claims … by
concluding that the payment of $ $2,144 made to the holder of 640 shares was a
windfall, the Court considered seven factors put forward by counsel for the
Crown, and said of them that they were all relevant “… although no one of them
by itself may be conclusive …”. The seven factors are:
The Respondent had no enforceable claim to the
(ii) there was no organized effort on the part of
the Respondent to receive the payment;
(iii)the payment was not
sought after or solicited by the Respondent in any manner;
the payment was not expected by the
Respondent, either specifically or customarily;
(v) the payment had no foreseeable element of
the payor was not a customary source of
income to the Respondent;
the payment was not in consideration
for or in recognition of property, services or anything else provided or to
be provided by the Respondent; it was not earned by the Respondent,
either as a result of any activity or pursuit of gain carried on by
the Respondent or otherwise.
 Cranswick must be read in
light of the fact that the trial judge’s statement that the payment was not
made by reason of any enforceable claim asserted by the shareholders of the
Canadian subsidiary results from a specific statement to that effect contained
in an agreed statement of facts. As Robertson J.A. said later in Bellingham
concession on the part of the Minister cannot be ignored for as the law
presently stands monies paid for the discharge of even a questionable legal
right may constitute income in the hands of the taxpayer.
The distinction between a voluntary payment and one
motivated by the prospect of litigation was central to the decision of the
Federal Court of Appeal in The Queen v. Mohawk Oil Co. These cases demonstrate
that, as Robertson J.A. said in Bellingham:
scope of the residual category
"windfall gains" has proven problematic. At best, it can be said that
a payment which is unexpected or unplanned and not of a recurring nature, is
more likely than not to be characterized as a windfall gain. But like all
generalizations, this observation must be scrutinized meticulously.
 It is not at all
clear that the appellant, or at least the trustee of his RRSPs, had no
enforceable claim to be compensated for the harm done by the fund managers
through their failure to protect the funds’ unit holders from the effects of the market timing activities. The fact that the payments
resulted from administrative action taken by the OSC rather than proceedings
begun by Mr. Lavoie, or the class action that is pending, does not affect the
purpose and character of the payments. Mr. Robertson argued that the payments
were in the nature of a penalty imposed by the OSC, but payable to the affected
investors. There was no direct evidence called by either party to shed light on
this, but it seems self-evident from all the surrounding circumstances,
including the terms of the Settlement Agreements and the Plans of Distribution,
that the purpose of the payments was in part to impose a penalty on the fund
managers, but also to compensate investors, at least in part, for their losses.
For example, a lengthy section of each Plan of Distribution is titled determination of recipients of payments, and
makes provision for characterization of “affected investor” status on the basis
of specific funds in specific accounts, and for payment to both former and
current unitholders. It was in the character of compensation that the appellant
and the other affected investors received their payments.
 Nor do the second
third and fourth Cranswick factors apply to characterize these payments
as windfalls. It is true that Mr. Lavoie, and presumably the other beneficial
owners of units as well, did not pursue claims or negotiate settlements with
the fund managers. Nevertheless, it was on their behalf that this was done by
the OSC. The Securities Act
of the province of Ontario has two clear purposes, stated in section 1.1:
1.1 The purposes of this Act are,
(a) to provide protection to
investors from unfair, improper or fraudulent practices; and
(b) to foster fair and efficient
capital markets and confidence in capital markets.
was in furtherance of these objectives that the OSC took the action that it did
to secure payments of compensation for the affected investors. It is clear from
the complex Plans of Distribution that the focus of the settlements and the
implementation of them was designed to provide compensation to the investors.
 It is not significant
that the payments in this case were an extraordinary event and not likely to
recur. These two criteria, if positive, might be considered indicia of payments
in the nature of income; in the negative they are a neutral factor. There are
many kinds of payments that may occur in isolation, but are nonetheless clearly
taxable. Withdrawals from RRSPs are the most obvious example, in the present
context. There is, of course, the possibility of further payments of
compensation to Mr. Lavoie and the other investors if the class action succeeds
in relation to Franklin Templeton and AIC.
 The final Cranswick
factor relied on by the appellant is that the payments were not made in
consideration for property, services or anything else provided by him, or as a
result of any activity on his part. Mr. Robertson emphasized in argument the
fact that a class action has been begun which includes claims against Franklin
Templeton and AIC for the very conduct that gave rise to the proceedings taken
by the OSC that resulted in the settlements in issue here. He points out that
Mr. Lavoie has signed no release, and may share in the proceeds of the action
as a member of the relevant classes. While this is undoubtedly so, it does not
change the nature of the payments made by Franklin Templeton and AIC under the
agreements negotiated by the OSC. The Plans of Distribution provide for payments to be
made only to unitholders who were adversely affected by the market timing
transactions, and for those payments to be proportionate to the degree of
adverse effect suffered by the payees in relation to the total adverse effect
on all unitholders. No payments from the settlement funds were to be made to
unitholders who experienced an overall benefit as a result of the market timing
transactions in a fund. From these provisions it is clear that the intention of
the OSC, and presumably the fund managers as well, was that the settlement
funds were to compensate unitholders for their losses.
 The compensatory
nature of the payments distinguishes this case from cases such as Cranswick
and Bellingham. In Bellingham,
the Federal Court of Appeal held that an award made under subsection 66(4) of
the Expropriation Act
of Alberta was in the nature of a penalty imposed on the expropriating authority,
and unrelated to the issue of fair compensation for the expropriated land. As a
penalty, rather than compensation, it was properly characterized as a windfall,
and so not subject to tax in the hands of the recipient.
 The question that
then arises is whether it is appropriate to apply the surrogatum
principle to these payments. Mr. Robertson says that it is not, because the
payments were not made in settlement of enforceable claims by Mr. Lavoie
against Franklin Templeton and AIC. There is no principled distinction to be
made between these payments and payments made in settlement of litigation, or
in satisfaction of a judgment for damages after trial. If the class action
results in judgment against Franklin Templeton and AIC then these payments
would be taken into account in the assessment of any damages to be recovered by
Mr. Lavoie. Both the majority and the dissenting judgments of the Supreme Court
of Canada in Tsiaprailis v. Canada
affirm the principle that “awards of damages and settlement payments are
inherently neutral for tax purposes”.
As Robertson J.A. stated in Bellingham, it is always necessary to look to the nature
and purpose of the payment when considering how it is to be treated for tax
purposes. As I have said above, the nature of these payments, in the hands of
the appellant, is that they were compensatory. They may have had more than one
purpose, but at least one of their purposes was to restore to Mr. Lavoie and
the other affected investors some or all of the diminution of the value of
their fund holdings.
 Charron J., writing
for the majority in Tsiaprailis, said at paragraph 15:
questions are: (1) what was the payment intended to replace? And,
if the answer to that question is sufficiently clear, (2) would the replaced
amount have been taxable in the recipient’s hands?
answer to the first question is clear from the Settlement Agreements and the
Plans of Distribution. It was the loss in value of the units. Under the Plans
of Distribution the payments were to be made to the holders, and former
holders, of units of the funds. For reasons that are not revealed in the evidence,
payments of compensation in respect of fund units held in RRSPs and other
tax-deferred registered plans were made payable by the Plans of Distribution to
the annuitants, although the Settlement Agreements provided for payments to the
unitholders. The surrogatum principle requires that the payments be
treated for tax purposes as though they were part of the Registered Plan held
by the trustee, because it is the value of those units that is to be restored,
in whole or in part, by the payments.
 The answer to Charron
J.’s second question, then, must depend on the tax treatment that would be
applied to a part of the Registered Plan if during the year it were to be in
the hands of the annuitant rather than the trustee. Subsection 146(8) brings
into the taxpayer’s income for the year
… the total of
all amounts received by the taxpayer in the year as benefits out of or under
registered retirement savings plans …
purposes of this section, the word “benefit” is defined in subsection 146(1).
any amount received out of or under a retirement savings plan other than
and without restricting the
generality of the foregoing includes any amount paid to an annuitant under
accordance with the terms of the plan,
resulting from an amendment to or modification of the
resulting from the termination of the plan;
Est comprise dans une prestation toute somme reçue dans le cadre d’un régime
d’épargne-retraite, à l’exception :
exceptions sont inapplicable]
de la portée générale de ce qui précède, le terme vise toute somme versée à
un rentier en vertu du régime :
d) soit conformément aux
conditions du régime;
e) soit à la suite d’une
modification du régime;
f) soit à
la suite de l’expiration du régime.
D.J. pointed out in Kaiser v. The Queen
the breadth given to this definition by the inclusion of the word “under” in
the English version, and the expression in the French version “dans le cadre”
has a similar effect. Applying the surrogatum principle to the payments
leads me to conclude that when the Appellant cashed the cheques and applied the
funds to purposes other than restoring the value of the fund holdings in his
RRSPs then those amounts fell to be treated as amounts received by him in the
year as benefits out of or under his RRSPs, and so were taxable in his hands.
 Mr. Lavoie made the
point in his evidence that he had no RRSP contribution room when he received
the payments in September 2005, the implication being that he could not have
turned the payments over to the trustee of his RRSPs without suffering a
penalty for overcontribution under Part X.1 of the Act. However,
consistency in the application of the surrogatum principle dictates that
the appellant could, on receipt of the payments, have handed them over to the
trustee to be added to the trust assets, without penalty. This is simply
recognition of the true nature of the payments, that is as compensation to the
trustee for wrongful impairment of the assets of the trust.
 Paragraph 24 of the
Agreed Statement of Facts reproduces in part the Tax and Information Guide that
was sent to the appellant with his payments. I can see no relevance to this
document, and I have not considered it in reaching my conclusion that the
payments are subject to tax. It is no more than the view of some unknown
individual, presumably employed by the fund managers or their consultant who
assisted in preparing the Plans of Distribution. I was also referred to the
Interpretation Bulletins IT-334R2 – Miscellaneous Receipts and IT
365R2 – Damages, Settlements and Similar Receipts issued by the Canada
Revenue Agency. I appreciate that Interpretation Bulletins may in some cases be
useful in resolving ambiguity in the provisions of the Act. I do not
consider this to be such a case.
 For the foregoing
reasons, the appeal is dismissed.
Signed at Ottawa, Canada, this 29th day of May, 2009.