Today, the swath that stretches 14 miles along the Lake Ontario shore and 28 miles inland is some of Canada's priciest real estate, including much of metropolitan Toronto, and the government wants to make amends.
It is negotiating with the 1,500 Mississaugas of the New Credit First Nation Indian band on a fairer payment.
"Canada has determined there was an outstanding legal obligation," Mississauga Chief Bryan LaForme, a former U.S. Army sergeant, told The Associated Press.
A government statement said settling the issue would resolve "a long-standing historical grievance" while providing LaForme's band with money to create economic development and business partnerships.
The deal for land that includes most of Toronto and dozens of nearby towns was improperly recorded by the British, leaving exactly what was paid for in 1805 unclear, said David Walker, a former Parliament member who heads the government's negotiating team.
"When you look at the record, the British Crown made a huge error of judgment because they didn't fill in the deed," Walker said.
While the British government and later an independent Canada claimed the land was purchased, the Mississaugas argued the money was paid for the tribe to protect settlers from raids organized by the Americans and Indian allies.
Thousands of British loyalists fled the United States after the American Revolution in 1776 and settled in Canada. "They needed Indian tribes to help defend these new settlers from potential American-organized attacks and to provide land where these people could settle," Walker said.
Neither Walker nor LaForme would speculate on a possible final figure. They rejected comparisons to other claims, such as a 200-acre land claim that earned LaForme's band $9 million a few years ago.
"You can't compare the two," LaForme said. "That was just stolen from us. The land we're talking about in the Toronto purchase was surrendered, so the land is not the issue, it's the compensation."
By comparison, the U.S. and New York state governments offered the Oneida Indian band $500 million last year for a claim involving 391 square miles. Negotiations on the matter are stalled, said S. John Campanie, a lawyer for Madison County, the chief area affected.
"Claims are proliferating throughout New York state from differing tribes, putting hundreds of thousands of acres in gray areas regarding residency, taxes and jurisdiction," Campanie said.
The Mississaugas first filed a claim for the Toronto purchase in 1986, but the Canadian government rejected it. In 1998, the matter was submitted to the Indian Claims Commission, an independent agency set up to review rejected claims, and it ruled the claim valid last year.
Now researchers will go to Britain to dig up records of similar transactions from the same era, Walker said.
"Negotiations will be governed by historical circumstances and the degree to which the Crown at the time did not treat the (Indian band) properly," he said.
Britain purchased the Toronto land in two deals, but no record was kept of the first transaction in 1787. In 1805, under the guise of ratifying the 1787 deal, the British paid 10 shillings - worth a little over $35 in today's currency - for double the original amount of land of the original agreement.
"It was not the same piece of property," Walker said.
Whatever amount the Mississauga Reserve about 60 miles southwest of Toronto ends up getting, it will be put into a trust fund, which will generate interest to be spent according to band plebiscites, LaForme said.
"It will be there for future generations," he said. "We're a very progressive community, so we can only see it enhancing what we have."
By Colin McClelland