Anonymised, illustrative composite. Counsel confirmed three statute-barred years and moved on. The provision that would have reopened them was two subsections away, and it changes the length of the indemnity, not its size.
At a glance
A regional private-equity buyer agreed to acquire the shares of an Alberta industrial cleaning contractor for $6,400,000. The target was a Canadian-controlled private corporation with a single shareholder group, twenty-two years of trading history and clean filing compliance — every T2 filed on time, every notice of assessment on file, no balance owing.
Tax diligence at this size is a sizing exercise: pull the notices of assessment, identify which years are still open, set the survival period on the tax representations to match. Standard practice, described in how long the CRA can come back and what that means for indemnities.
Three of the six years under review had aged past the normal reassessment period. Counsel wrote them off as closed, set a 36-month survival on the tax representations, and let the tax indemnity sit inside the general indemnity cap of $640,000.
Then the financial diligence team asked what a recurring $15,000 monthly line called management and advisory was. It was paid to a numbered company owned by the vendor’s spouse. There was no services agreement, no invoices describing work, no time records, and nobody at the target could name a deliverable. The vendor’s own accountant had raised it in a file memo in 2021 and had been told to leave it.
That finding does not sit inside the closed years. It is the thing that opens them.
The management fee ran at $180,000 a year for six years, $1,080,000 in total, of which $540,000 fell in the three years counsel had treated as closed. The vendor’s accountant put the additional tax across those three years at $291,000.
On top of that sits the gross-negligence penalty. It is not a percentage of the deduction and not a percentage of the year’s tax; it is calculated on the tax attributable to the false statement, which on this file is the same $291,000. Fifty per cent of that is $145,500. Before arrears interest, the three “closed” years carried $436,500 of exposure against an indemnity cap of $640,000 that also had to cover employment, environmental and every other representation in the agreement.
The 36-month survival was the more serious defect. An audit of a corporation this size does not reliably open within 36 months of closing, and it would have to be opened, worked and assessed before the buyer could quantify a claim at all.
Three provisions, and the order matters.
First, the length of the window. Income Tax Act s.152(3.1) defines the normal reassessment period as four years for a corporation other than a Canadian-controlled private corporation, and for everyone else “the period that ends three years after the earlier of the day of sending of a notice of an original assessment under this Part in respect of the taxpayer for the year” and the day of sending of an original notification that no tax is payable. Note the start date: it runs from the day the original notice of assessment was sent, not from the corporation’s year end. On a late-filed or late-assessed year those are months apart.
Second, the exception. Under s.152(4) the Minister may assess after the normal reassessment period 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”. An undocumented related-party fee, queried internally and left in place, is squarely the kind of item that argument is built on.
Third — and this is the part the shorthand gets wrong — reopening a year does not reopen all of it. Section 152(4.01) allows the reassessment to be made after the normal reassessment period only “to the extent that, but only to the extent that, it can reasonably be regarded as relating to” the misrepresentation. The exposure is item-scoped, not year-scoped. The buyer is not exposed to a fresh audit of everything in 2019; it is exposed on the management fee, and on whatever else in those years shares the same defect.
The penalty is separate. Section 163(2) catches a person who “knowingly, or under circumstances amounting to gross negligence” made a false statement or omission in a return, and makes them “liable to a penalty of the greater of $100 and 50% of the total of” the amounts the section then defines — on these facts, the tax attributable to the false statement. Section 163(3) puts the onus where it belongs: “the burden of establishing the facts justifying the assessment of the penalty is on the Minister”. That is a real defence, but it is a defence to the penalty, not to the reassessment.
The buyer did not retrade the price. It restructured the indemnity, because time, not amount, was the variable.
The tax indemnity was carved out of the 36-month survival period entirely and given its own term: it survives until 90 days after the last of the affected taxation years is finally determined, including any objection or appeal. It was also carved out of the $640,000 general cap and given a separate cap equal to the reassessment plus penalty plus interest. A $500,000 escrow was funded from the closing proceeds to sit behind it, released in tranches as each year is either assessed or becomes genuinely unavailable to the Minister. See the survival period glossary entry and the indemnity cap entry for the drafting mechanics.
Correcting the filings was left to the vendor and its accountant on their own advice, but the agreement obliged the vendor to notify the buyer of any filing touching the affected years.
The 36-month survival was the whole risk. Had it stayed, the sequence is easy to predict: closing, then thirty-six quiet months, then survival expires, then a CRA audit letter arrives in month forty-one asking about management fees. At that point the buyer owns a corporation carrying a reassessment on three years it never operated, a gross-negligence penalty on top, and no contractual route back to the vendor because the representation it would have claimed under no longer exists.
The $640,000 cap was the second-order problem: even inside survival, a $436,500 tax claim consumes two-thirds of a cap also carrying the employment and environmental representations.
A notice of assessment tells you when a window opened. It cannot tell you whether it closed, because whether it closed depends on facts the notice does not contain.
The tell was not in the tax file at all: a round, unvarying monthly payment to a related party with no agreement behind it, visible in the related-party note and already flagged in the vendor’s own working papers. Anyone reading related-party transactions inside the accounts before deciding the survival period would have set it differently.
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