Anonymised, illustrative composite. The audit letter arrived the same week the deal team was finalising the closing checklist.
At a glance
A buyer was three weeks from closing on a food-manufacturing co-packer, purchase price $4,200,000, when the seller disclosed that the CRA had just opened an income-tax audit reviewing whether a category of expenses had been correctly deducted across the corporation’s three most recent taxation years.
Neither side wanted to walk. The buyer wanted to know exactly how much exposure it was inheriting, and for how long the seller’s indemnity actually needed to survive to cover it — not a market-convention guess, but a figure tied to when CRA’s power to reassess actually runs out.
The seller’s accountant estimated realistic exposure at $60,000 per year across the three years under review — $180,000 in total — if CRA disallowed the expense category entirely. ITA s.152(3.1) — marginal note Definition of normal reassessment period — does not set one period for corporations. It sets four years for “a mutual fund trust or a corporation other than a Canadian-controlled private corporation,” and three years “in any other case,” each running from the earlier of the sending of the original notice of assessment and the sending of a notification that no tax is payable. The distinction is worth confirming before an escrow is sized to it: the target here was a CCPC, so three years was the operative clock, but the same clause would have given a buyer of a non-CCPC a year more exposure than the deal team was pricing. Section 152(4)(a)(i) removes the limit entirely only where the taxpayer “has made any misrepresentation that is attributable to neglect, carelessness or wilful default or has committed any fraud in filing the return or in supplying any information under this Act” — and s.152(4)(a)(ii) also keeps a year open indefinitely where the taxpayer has filed a waiver within the normal reassessment period, which is why the buyer asked, in writing, whether any waiver had been signed. None had. This was a standard expense-classification review, not a fraud allegation. The parties escrowed the full $180,000 estimate at closing, seller cash reduced to $4,020,000, with release tied to the earlier of the audit’s resolution or the expiry of the s.152(3.1) three-year period on the not-yet-reassessed year.
The escrow term was not a market convention borrowed from an unrelated deal — it was the statute’s own reassessment window, applied directly. That same discipline shaped the buyer’s access to records: ITA s.230(4)(b) requires books and records to be kept “until the expiration of six years from the end of the last taxation year to which the records and books of account relate,” so the seller’s post-closing cooperation covenant — access to records and personnel to respond to CRA — was written to run the full six years, not just the three-year escrow term, since CRA could still request records for that whole window even after the reassessment period itself had closed. The covenant also picked up s.230(6), which extends the retention obligation past six years for as long as a notice of objection or an appeal to the Tax Court is outstanding: six years is the floor, not the ceiling, and an audit that turns into a dispute outlives it.
The audit resolved fourteen months later. CRA disallowed the deduction in two of the three years reviewed — $80,000 — plus $9,400 in interest and penalties, for a total of $89,400. The escrow paid that amount to the Receiver General in settlement of the reassessment — the corporation being, by then, the buyer’s — and released the remaining $90,600 ($180,000 − $89,400) to the seller.
Had the buyer instead insisted on a flat $180,000 purchase-price reduction at signing, rather than an escrow tied to the actual outcome, the seller would have given up $90,600 more than the audit ultimately cost — money that belonged to the seller once the real exposure turned out to be $89,400, not $180,000. An escrow “retained…for a set period so the buyer has a source of payment if…a pre-closing liability surfaces” protects both sides of that gap, where a straight price cut protects only the buyer’s worst case.
The tell was timing, not substance: a seller who becomes noticeably less available for scheduled diligence calls in the exact week CRA correspondence would plausibly have arrived by mail is worth a direct question before assuming the delay is unrelated. A bring-down of representations at closing, confirming no new undisclosed liabilities have arisen since signing, is what actually catches this — not a general materiality clause written before the audit existed.
One detail nearly derailed the escrow’s release condition rather than its size. The parties’ first draft tied release to “the audit’s resolution or three years from closing,” without specifying which year the three-year clock ran from — and s.152(3.1) runs separately for each taxation year, from the date of that year’s own original assessment, not from the closing date of an unrelated transaction. Corrected before signing, the escrow instead named each of the three reviewed years and its own reassessment-period expiry individually, so the release condition matched three real dates on three real notices of assessment rather than one approximate one.
A 30-minute call can tell you whether an escrow on your next deal is sized to the actual statute, or to a guess.
