What is a spy?

They're not a legal immigrant, because they lied on their immigration papers, making their immigration invalid.

If they're an illegal immigrant, their children would be granted citizenship.

If they're a diplomat, their children would not be granted citizenship. The child of the Russian Ambassador does not become a Canadian citizen even if born and raised in Toronto.

I think the government's argument that they're more like a diplomat (an agent of a foreign country) than an undocumented resident (e.g., someone who's entered the country of their own volition for work) is pretty sound.