The Supreme Court of Canada says that Ottawa illegally collected employment insurance contributions for three years under the former Liberal government.

The court, though, rejected union claims that Ottawa diverted money from deliberately-over-inflated EI surpluses to balance the federal budget and fund programs.

In a 7-0 decision, the court ruled EI premiums were inappropriately collected between 2002, 2003, and 2005. That's when the Liberal cabinet set EI rates directly without the authorization from Parliament and the employment insurance commission, a violation of the principle of no taxation without representation.

"This means that employment insurance premiums were collected unlawfully, without the necessary legislative authorization," Justice Louis LeBel wrote in the decision.

Canada's highest court ruled, however, that the federal government was within its rights to divert EI contributions to pay down the deficit from 1996-2001.

It also noted that the court's declaration would be suspended for a period of 12 months to allow the government to respond.

• Read the full text of the court's ruling by clicking on the right-hand link

A Quebec labour union first raised the issue, claiming that Jean Chretien's Liberal government diverted $54 billion from unemployment insurance contributions made by employers and their workers.

The Confederation des Syndicats Nationaux claimed the government was using the money unconstitutionally to balance the budget. Labour leaders demanded that the Ottawa take the money out of general revenues and return the money to the EI program.

The Canadian Labour Congress wanted the money to:

• boost EI's future benefits
• or offset future increases in EI premiums

Before the ruling, the governing Conservative government had not agreed to return the $54 billion diverted from the EI fund. But Ottawa had said it would set up an independent crown corporation to run the program on a break-even basis.

Federal lawyers argued before the ruling that the Confederation des Syndicats Nationaux demands would put future governments in a "constitutional straitjacket" in managing the system.

The debate over how EI premiums could be used began in the 1990s, when Paul Martin, then-prime minister Jean Chretien's finance minister, brought in new EI legislation.

New rules made it more difficult for laid off workers to be eligible for benefits, but they also brought in new training programs.

Critics had argued the government was raising EI premiums to fund the new programs, while cutting benefits for those out of work.

With files from The Canadian Press