A Canada Revenue Agency (“CRA”) audit initiative is targeting taxpayers who have recently sold condominium units they did not occupy or occupied for only a short period of time (the “CRA Condo Project”).

The CRA is reassessing some of these dispositions on the basis that the condo was sold in the course of business, treating the profit as income (instead of capital gains) and, in some cases, assessing gross negligence penalties under subsection 163(2) of the Income Tax Act. In doing so, the CRA may be incorrectly reassessing some taxpayers whose gains are legitimate capital gains and that may be subject to the principal residence exemption (click here for a discussion of the principal residence exemption).

Consider this example. A taxpayer signs a pre-construction purchase agreement for a condo in 2007.  In 2009, the unit was completed and occupied by the taxpayer, before the entire development was finished and registered in land titles.  Land titles registration occurs in 2010, but shortly thereafter the taxpayer sells the condo for a profit.  Ordinarily, one would conclude the condo was held on account of capital and the gain would be at least partially exempt from tax on the basis that condo was the taxpayer’s principal residence.  The CRA may be inclined to reassess on the basis that land title records show the taxpayer on title for only a short time, as though the taxpayer had intended to merely “flip” the condo rather than reside in it.

This assessing position may be incorrect because the buyer of a condo does not appear on title until the entire condominium development is registered.  In fact, several years can pass from the date of signing the purchase agreement to occupancy to land titles registration – and, accordingly, the taxpayer’s actual length of ownership will not be apparent from the land title records.

This type of situation could cause serious problems for some taxpayers. If a taxpayer is audited and subject to reassessment on the basis that their entire gain should be taxed as income, the taxpayer will need to gather evidence and formulate arguments in time to respond to an audit proposal letter within 30 days, or file a Notice of Objection within 90 days of the date of a reassessment.

Taxpayers could respond to such a reassessment by providing evidence that they acquired the condo with the intent that it would be their residence, and that the subsequent sale was due to a change in life circumstances.  Taxpayers may wish to gather the following evidence to support such claims:

• Purchase and sales agreements;
• Letter or certificates granting permission to occupy the condo;
• Proof of occupancy, such as utility bills, bank statements, CRA notices, identification (such as a driver’s license) showing the condo as a residence; or
• Evidence of a change in life circumstances which caused the condo to no longer be a suitable residence, including:
  • Marriage or birth certificates;
  • A change of employer or enrollment in education that required relocation; or
  • Evidence showing the taxpayer cared for a sick or infirm relative, or had a disability that precluded using a condo as a residence.

Taxpayers should be prepared to provide reasonable explanations for any gaps in the evidence.  If a taxpayer wishes to explore how best to respond in the circumstances, they should consult with an experienced tax practitioner.

The June 6th breakfast meeting of the Toronto Centre CRA & Professionals Group promises to be particularly informative. It features presentations from senior Ottawa CRA officials on the work of the Rulings Directorate and the CRA’s administration of the General Anti-Avoidance Rule. This is in addition to the case comments provided by Cliff Rand of Deloitte Tax Law LLP and Arnold Bornstein of the Department of Justice.

Please click here to register for the June 6th breakfast meeting.

The Canada Revenue Agency had an important win this week in its efforts to access information outside of Canada.  On March 20, 2013, the Federal Court issued its decision in Soft-Moc Inc. v. M.N.R.  2013 FC 291, dismissing Soft-Moc’s judicial review application to have the CRA’s decision to issue a Foreign-Based Information Requirement set aside or varied.

The CRA has broad powers to access information related to the determination of a taxpayer’s tax obligations.  Under subsection 231.6 of the Income Tax Act, these powers include the issuance of a Foreign-Based Information Requirement to obtain information or documents located outside of Canada.

In Soft-Moc, the CRA was conducting a transfer pricing audit and sought information from corporations in the Bahamas who provided services to Soft-Moc.  These corporations and their individual Bahamian resident shareholder owned 90% of the common shares of Soft-Moc.  The CRA issued a Foreign-Based Information Requirement to Soft-Moc under subsection 231.6(2) of the Income Tax Act. 

The Requirement requested substantial amounts of information related to the Bahamas Corporations including extensive details of the services provided, customers, financial statements, costs and profits and employee data.  Soft-Moc applied for judicial review of the decision to issue the requirement. 

Primarily, Soft-Moc argued that the information requested went well beyond that necessary to enable the CRA to complete the transfer pricing audit and that the decision to issue the requirement was, therefore, unreasonable.  Soft-Moc argued that a portion of the information requested was irrelevant and that some portions were confidential or proprietary. 

The Court was not sympathetic to Soft-Moc’s arguments, noting the wide-ranging statutory powers of the CRA to collect information and the low threshold to be met in determining whether the requested information is relevant and reasonable. 

This win, which was not surprising in light of the Federal Court of Appeal’s earlier decision in Saipem Luxembourg S.A. v. The Canada Customs and Revenue Agency, 2005 FCA 218, will encourage the CRA to continue to use foreign-based requirements more frequently and earlier in the audit process.

A tax dispute with the Canada Revenue Agency may be an unwelcome and unpleasant experience for a taxpayer. In addition to the potentially complex tax issues, the dispute resolution process itself can be a nuanced and challenging process. However, an appeal to the Tax Court of Canada offers taxpayers a chance to have their disputes considered by “fresh eyes,” which could result in a victory, settlement or other efficient resolution.

In the March 15, 2013 issue of The Lawyers Weekly, I discuss some of the ways a tax appeal differs from a typical civil trial.

The taxpayer in this case, NRT Technology Corp, successfully applied before the Federal Court for judicial review in respect of a decision of an Assistant Director of the Toronto Tax Services Office of the Canada Revenue Agency denying NRT’s request for the cancellation of a penalty under the Taxpayer Relief Provisions pursuant to subsection 220(3.1) of the Income Tax Act (Canada). The style of cause is NRT Technology Corp v. Attorney General of Canada, 2013 FC 200.

Background

On February 26, 2006, NRT paid a bonus to its President in the amount of $7,093,000 (the “Bonus”). On March 14, 2006, NRT remitted corresponding withholding payroll taxes in the amount of $2,848,548.80. On March 23, 2006, CRA assessed NRT for a 10% late remitting penalty in the amount of $284,805 as NRT had accelerated remitter status which it was notified of by the CRA in November 2005. CRA determined that NRT ought to have remitted the $2,848,548.80 on March 3, 2006 and its failure to do so warranted the assessment of a penalty.

Upon payment of the Bonus, NRT was advised by its tax advisor to hold off on the payroll remittances to the CRA until further instruction was received by her. On March 13, 2006, NRT’s tax advisor indicated that she had been advised by the CRA that NRT was obliged to withhold and remit the full amount of tax due on the payment of the Bonus by March 15, 2006. On March 14, 2006, NRT remitted the payroll taxes on account of the payment of the Bonus.

The First Taxpayer Relief Request

On November 9, 2006, in response of a relief request dated September 13, 2006 by NRT, the CRA denied the request stating that a “review of the account history and the circumstances outlined in [NRT’s] letter [had] failed to substantiate that [NRT was] prevented from complying with the [CRA’s] requirements.” The CRA further indicated that NRT failed to demonstrate that the lateness was the result of extenuating circumstances or the result of CRA departmental error and that as a result, the directors of NRT did not exercise reasonable care with respect to the remittance.

The Second Taxpayer Relief Request

On July 18, 2007, NRT filed for a second administrative review in relation to the taxpayer relief request. In a letter dated December 14, 2007, the Director denied the requested relief.

Under the second level review process, an officer reviews the applicant’s second level review submissions and prepares a recommendation report for the review of the Director. The Director then decides whether to grant the relief sought. In this case, the officer’s report and ultimate decision made by the Director and communicated to NRT by letter dated December 14, 2007 were at issue (the “Decision Letter”).

The officer’s report recommended that relief should not be granted on the basis that NRT exhibited a degree of carelessness in its handling of the Bonus and failed to act quickly to remedy the error. In accepting the recommendation in the officer’s report, the Decision Letter indicated that there was no evidence that NRT was misdirected by the CRA or that the CRA failed to provide information to NRT in a timely manner. It was further stated that NRT was careless in its handling of the bonus and was not quick to remedy the error.

The focus of the Federal Court’s analysis was on the reasonableness of the impugned second level decision.

The Applicant’s Argument

It was NRT’s contention that given the broad authority available to the Minister to grant relief under s. 220(3.1) and the extraordinary circumstances, the Minister’s decision to deny relief was unreasonable. Further, no reasons were given as to how NRT failed to quickly act to remedy the error that had been committed. NRT noted that once its tax advisor had advised it to remit, it did so without delay.

The Respondent’s Argument

In noting that deference was owed to the CRA under the reasonableness standard of review, the Crown reiterated its reasons as outlined in the Decision Letter in support of its position.

The Decision of the Federal Court

The Federal Court noted that it was not clear what exactly the “error” was which was not acted upon quickly enough. If the “error” was failing to remit on or before March 3, 2006, this error was rectified with NRT’s remittance on March 14, 2006, a day after it was advised by its tax advisor that such remittance was required immediately, contrary to NRT’s belief that the remittance was required by March 15, 2006.

If the “error” was not paying the penalty in a timely manner, the Federal Court noted that the offsetting amount pursuant to the flow-through shares acquired by NRT was not accounted for until August 2006. As such, there was no way for NRT to know how much was owed until that time. Moreover, the reduced amount owing was offset against GST refunds in November 2006. If this was in fact the “error” referenced in the Decision Letter, NRT had taken steps to reduce the amount and ultimately settle the balance in a timely manner.

As there was no indication in the Decision letter as to what the “error” was, why NRT’s rectification was not sufficiently prompt, or how NRT could have rectified the situation more quickly, the Federal Court concluded that the reasoning in the Decision Letter was equivocal. The steps taken by NRT were supportive of its claim that it quickly remedied its failure to remit the amount due and that it took steps to address the penalty owed. The Court therefore found in favor of NRT, concluding that the “…Director’s decision that NRT failed to quickly remedy the error to be unreasonable as it fails the requirements of being justified, transparent and intelligible as required under Dunsmuir.”

Reflections

The impact of this decision goes beyond merely chastising the CRA for a poorly written letter. There appears to be a “cut and paste” approach applied by the CRA from time to time which may cause a reasonable observer to believe that the taxpayer’s circumstances were not fully considered, particularly where the taxpayer’s conduct reflects a considerable degree of due diligence.  It is hoped that this decision will cause those at the CRA who are responsible for reviewing taxpayer relief requests to thoroughly consider the circumstances of each case, particularly where quick action was taken in the direction of compliance - taxpayers deserve no less.

On February 21, 2013, the Federal Court of Appeal released two decisions related to the obligations of the Minister of National Revenue when making ex parte applications under subsection 231.2(3) of the Income Tax Act (the “Act”) for judicial authorization requiring taxpayers to produce certain information and documents relating to customers.  In Minister of National Revenue v. RBC Life Insurance Company et al., 2013 FCA 50, the FCA affirmed the decision of the Federal Court (reported at 2011 FC 1249) cancelling four authorizations issued by the Federal Court in relation to customers of the Respondent companies who had purchased a particular insurance product that has been described as “10-8 insurance plans”.  In Minister of National Revenue v. Lordco Parts Ltd., the FCA adopted its reasoning in RBC and again affirmed a judgment of the Federal Court cancelling an authorization that had required information in respect of certain employees of the Respondent.

In both cases, the FCA reaffirmed the Minister’s “high standard of good faith” and the powers of the Federal Court to curtail abuses of process by the Crown.

In RBC, the Minister argued that the facts that it failed to disclose on its ex parte application before the Federal Court were not relevant to the applications. Reviewing the judgment of the Federal Court, the FCA concluded that the Minister failed to disclose the following facts:

• The Department of Finance’s refusal to amend the Act;
• Information in an advance income tax ruling;
• CRA’s decision to “send a message to the industry” to chill the 10-8 plans; and
• The GAAR committee had determined the plans complied with letter of Act.

The FCA held that the Federal Court’s finding that these facts were relevant was a question of mixed fact and law and the Minister had not demonstrated palpable and overriding error by the Federal Court judge. At a minimum, this suggests the Crown may have to disclose information of the sort included in the enumerated list.  Examining that list is interesting and suggests a requirement to include in the disclosure to the Federal Court judge hearing an ex parte application facts related to legislative history and intent including discussions about potential problems and possible legislative “fixes”, internal analysis of issues within the CRA including other advance income tax rulings, motivations on the part of the CRA and its officers and agents that may extend beyond auditing the particular facts, and previous analysis of the facts known  to the CRA and indications that those facts might support compliance with the Act and inapplicability of the GAAR.  That is a very extensive list, and it is encouraging to know that Crown obligations extend into each of these areas.

Further, the FCA held that even if the Federal Court on review of an ex parte order determined that the Minister had a valid audit purpose, it was open to the Federal Court to cancel the authorization based on the Minister’s lack of disclosure.  Somewhat surprisingly, the Minister argued that section 231.2(6), unlike section 231.2(3), did not allow for judicial discretion. Once the statutory conditions are established, the Minister argued, the Federal Court judge MUST NOT cancel the authorizations, no matter how egregiously the Crown acted.  The FCA rejected this argument, reaffirming the importance of judicial discretion and the duty of the Minister to act in good faith:

[26] In seeking an authorization under subsection 231.2(3), the Minister cannot leave “a judge…in the dark” on facts relevant to the exercise of discretion, even if those facts are harmful to the Minister’s case: Derakhshani, supra at paragraph 29; M.N.R. v. Weldon Parent Inc., 2006 FC 67 at paragraphs 153-155 and 172. The Minister has a “high standard of good faith” to make “full disclosure” so as to “fully justify” an ex parte order under subsection 231.1(3): M.N.R. v. National Foundation for Christian Leadership, 2004 FC 1753, aff’d 2005 FCA 246 at paragraphs 15-16. See also Canada Revenue Agency, Acquiring Information from Taxpayers, Registrants and Third Parties (issued June 2010).

The Minister’s argument, the FCA held, also runs contrary to the inherent power of the Federal Court to “redress abuses of process, such as the failure to make full and frank disclosure of relevant information on an ex parte application” (para 33):

The Federal Courts’ power to control the integrity of its own processes is part of its core function, essential for the due administration of justice, the preservation of the rule of law and the maintenance of a proper balance of power among the legislative, executive and judicial branches of government. Without that power, any court – even a court under section 101 of the Constitution Act, 1867 – is emasculated, and is not really a court at all. (para 36)

Overall, the RBC decision strongly reaffirms the role of the Federal Court in ensuring the Minister acts in good faith when making ex parte applications.  Given the broad powers granted in subsection 231.2(3) and elsewhere in the Act, it is reassuring to know that the Courts can, and will, protect taxpayers and citizens generally by ensuring that the CRA puts all relevant information before the Court when it seeks to exercise those powers.

On February 6, 2013, at the Toronto-Centre Tax Professionals Breakfast Seminar, the Canada Revenue Agency discussed its current strategic activities and priorities and changes to the Scientific Research & Experimental Development (SR&ED) program.

Strategic Direction

Derrick Smith, Director of Policy Integration and Coordination Division of the Strategic Policy Directorate, Strategy and Integration Branch, presented on the CRA’s current strategic activities and priorities. A brief overview of the issues he discussed are as follows:

• Intelligent compliance management: The CRA is increasing its use of business intelligence and advanced analytics to ensure more efficient and effective compliance intervention. This is inspired in part by Australia’s “industry campaign” approach and may include informing taxpayers of errors or other methods of encouraging compliance before a formal audit.
• Integration of taxpayer experience: The CRA intends to create more online tools for taxpayers to minimize interaction with the CRA and simplify access to information and services. This is similar to the U.S. digital government strategy and the Australian Centrelink initiative.
• Early certainty about tax issues: The CRA intends to facilitate advance decisions, update technical bulletins by soliciting the assistance of private practitioners with the oversight of the CRA, and develop the online Quick View interface for taxpayers to learn about the status of charities.
• Influence compliance attitudes: The CRA will use advertising campaigns and social media to attempt to change moral attitudes towards tax compliance. The CRA cited the recent announcement by Starbucks that it will voluntarily pay tax in the United Kingdom after a public outcry over the corporation’s tax planning.
• Increased reliance on third parties: The CRA will reach out to third parties to help achieve policy goals. This may take a variety of forms including engaging academics for discourse on policy, partnering with provinces and territories to address the underground economy, engaging in social media, and inviting tax practitioners to be involved in the production of CRA commentary.
• Continued transition to electronic communications: The CRA continues its efforts to encourage Canadians to file electronically and engage the online tools available to them.
• Improved use of collected data: The CRA has amassed substantial financial and tax data, but this data is not being efficiently stored or accessed in the CRA’s computer systems. The CRA intends to enhance the use and usability of the data available to it.
• Optimized organization and workforce: The CRA intends to modernize its workforce and working environment.

SR&ED Formal Pre-Approval Process

Nancy Karigiannis, Research & Technology Policy Coordinator for the Technical Guidance Division of the Scientific Research & Experimental Development Directorate, Compliance Program Branch, discussed the CRA’s initiative to streamline the SR&ED program. In particular, Ms. Karigiannis discussed recent initiatives to enhance the online accessibility and self-assessment tools available to taxpayers and the newly developed Formal Pre-Approval Process (“FPAP”).

The FPAP is a response to the report submitted by the expert federal panel on R&D to the federal government in October 2011, called Innovation Canada: A Call to Action, which called for the simplification of the SR&ED program (among other initiatives). After conducting a feasibility study and consulting internal and external industry experts, the CRA is now ready to initiate an FPAP pilot program and is looking for a diverse selection of claimants who are willing to participate.

The CRA intends to provide enhanced predictability to SR&ED applicants by allowing the CRA to conduct eligibility determinations in “real time” (i.e., during the development process) instead of after the application has been filed. The CRA will provide feedback to participants on agency expectations, the type of supporting evidence necessary for compliance, and other advice regarding filing requirements. By the end of the service, the necessary materials should be complete and ready for filing minimizing year-end work for the taxpayer.

Taxpayers interested in taking part in the FPAP pilot program should consult the requirements for eligibility and be certain to contact the CRA before February 14, 2013.

The Canada Revenue Agency has now published a set of answers to questions and concerns about the audit process presented to it by the Tax Executives Institute late last year (see our earlier blog post).

One of the highlights is the set of answers by the CRA to a series of questions about its new risk-based audit process.  The questions and answers on that subject are as follows:

Question 12 – Risk-based Audit Process

In 2011 CRA announced it was instituting a risk-based approach to audits whereby CRA would meet with senior representatives of the taxpayer to:

• Explain the redefined risk-based approach to large business compliance and how the approach affects taxpayers;

• Share CRA’s findings and observations noted during the taxpayer’s risk assessment; and

• Understand how the taxpayer manages tax risk at its highest governance levels.

With the first round of meetings with taxpayers complete, TEI has the following questions in respect of the approach:

a) Would CRA share its general observations, findings, trends, or conclusions with respect to the state of tax-risk governance?

Response by CRA:

The Approach to Large Business Compliance is being phased in over a five-year period commencing in 2010-11. During this period, CRA officials conduct meetings with Large Business enterprises’ senior executives to discuss tax compliance and risk of non-compliance associated with their business activities, governance regime, internal controls, and inherent and behavioral risk factors affecting their risk segmentation. At this point in time, it is still premature to draw general conclusions on the state of tax-risk governance. We have noted that there are taxpayers with no formal method of identifying and responding to corporate tax risk. These taxpayers are informed that this lack of tax risk governance, in the absence of other mitigating controls, will weigh negatively on their overall risk rating with the CRA.

b) In the interests of transparency, will CRA consider publishing a document outlining and discussing its review and risk-assessment process?

Response by CRA:

The CRA is of the view that the success of the Approach to Large Business Compliance is based on a well-informed, transparent tri-partite relationship. Providing further information on the risk assessment process in a published document would be in the best interests of all parties. As this initiative unfolds, the CRA will be in a better position to further communicate the risk-assessment process.

c) Has the first round of meetings with taxpayers led CRA to consider changes to its risk-assessment process and will it publicly announce the changes? Will affected taxpayers be apprised of changes to the scope of the risk-management approach that apply to their cases?

Response by CRA:

There have been no major changes in the risk assessment process. As expected, we are fine-tuning our risk assessment process and exploring ways to leverage technology in our drive to a more automated state and enhanced accuracy and efficiency.

d) Will CRA review the risk assessment with the affected taxpayer, including discussing the criteria and factors used to determine a taxpayer’s risk rating? If a taxpayer disagrees with its risk-assessment rating, what steps can it take to address its concerns?

Response by CRA:

During the face-to-face meetings, the taxpayer is informed of their risk rating. At that time, they will be informed of why they have attained this rating and what can be done to reduce the rating in the future. It is, however, not a debating forum where taxpayers can “negotiate” a better rating.

e) Assuming a taxpayer’s risk profile can change over time, will CRA revisit its risk-assessment ratings on a regular basis? If so, how often will the assessment be revised? Will CRA meet again with the taxpayer’s senior executives to review the revised rating?

Response by CRA:

Each taxpayer is risk assessed on a yearly basis based on the latest available information. Currently, as for the meetings, CRA officials are meeting with each Large Business taxpayer and discussing their individual risk rating over the 5-year phase-in period. Once this round of meetings is completed, CRA will consider revisiting taxpayers to review their rating.

f) Can CRA provide any details about the factors affecting a taxpayer’s risk rating?

Response by CRA:

The CRA’s Approach to Large Business Compliance (ALBC) discloses the criteria used in risk evaluating all taxpayers. The large business population is being risk assessed using several techniques, such as:

• Undertaking a historical analysis of audit results and a corresponding analysis of behavioural patterns;

• Examining every large business taxpayer in their TSOs and assessing their risk based on analysis and local knowledge;

• Conducting issue-based risk assessment to determine whether taxpayers are participating in tax planning schemes;

Additionally, consideration is being given to a number of risk factors, such as:

• Audit history;

• Industry sector issues;

• Unusual and/or complex transactions;

• Corporate structure;

• Major acquisitions and disposals;

• International transactions;

• Corporate governance;

• Participation in aggressive tax planning; and

• Openness and transparency.

These factors will vary by taxpayer and the taxpayers will be advised as to the factors considered in their risk assessment when the ALBC approach is discussed, in the face to face meeting that the CRA will hold with them. All factors are considered collectively in arriving a global risk rating for the entity.

g) Will CRA inform other tax jurisdictions (provincial or foreign) of its findings in respect of a taxpayer’s risk rating?

Response by CRA:

CRA has not shared any information related to any taxpayer’s risk rating with any other tax jurisdiction. In the future, any request made by another tax jurisdiction will be reviewed by the CRA on a case by case basis, while respecting the Provision of Information laws outlined in section 241 of the Income Tax Act and the relevant international exchange of information protocols.

h) What guidance has been provided to the TSOs to ensure that the objectives of the new audit approach are applied consistently by all the TSOs?

Response by CRA:

Given the prominence of risk assessment and the impact of risk rating on the design and implementation of the Approach to Large Business Compliance, a national risk assessment calibration committee has been formed to supplement the regional calibration committees thus ensuring national and regional consistency.

In certain other responses, the CRA refers to its strategic plan entitled “Vision 2020″ (question 2) and issues around Scientific Research & Experimental Development (question 3).  Both subjects will be discussed in detail at a breakfast seminar of the Toronto Centre CRA & Professionals Group at the Toronto Board of Trade to be held on Wednesday, February 6, 2013.

On January 10, 2013, the Canada Revenue Agency released its 2011-2012 Advance Pricing Arrangement Program Report (previous reports are available here).

This is the eleventh year in which the CRA has issued such a report, which is generally intended to enhance taxpayer awareness of the APA program and to describe (i) current operational status, (ii) relevant changes, and (iii) issues that may affect the program in future years.

The general purpose of an APA is to create certainty between the taxing authorities of Canada and a foreign country concerning the transfer pricing of cross-border intercompany transactions.  In the absence of an APA governing such transactions, taxpayers may be exposed to higher audit risk relating to their intercompany transfer pricing methodologies, which may ultimately result in costly and time-consuming negotiations with the multiple tax authorities as well as potential litigation. Accordingly, the CRA encourages taxpayers to avail themselves of the APA program to mitigate the transfer pricing risk in the appropriate circumstances, particularly where the taxpayer engages in intercompany transactions of a recurring nature (i.e., frequent sale of goods between affiliates or the ongoing provision of intercompany services).

The APA program has proven popular with taxpayers over the years and the number of applicants continues to grow – the 2011-2012 fiscal year had the highest number of applicants to the program (34) since the 2007-2008 fiscal year.  The inventory of unresolved cases also continues to grow (the inventory increased from 96 at the end of the 2010-2011 fiscal year to 102 at the end of the 2011-2012 fiscal year).  In the 2011-2012 fiscal year, 17 new cases were admitted to the APA program whereas only 10 cases were completed (and one was withdrawn).  The large discrepancy between the number of applicants and the number of cases formally admitted to the program in the year is partially a reflection of the changes introduced by the CRA beginning in the 2010-2011 fiscal year requiring that taxpayers invest significantly more time and resources during the initial application/due diligence phase of the APA process and to provide a greater amount of financial and business information prior to acceptance into the program.  This results in a longer and more extensive “screening” process but is intended to eliminate inappropriate cases before they are accepted into the program inventory.

Other highlights of the Report include:

• The average amount of time required to conclude a bilateral APA from acceptance into the program until completion was 44 months, which appears generally consistent with prior years;
• The majority of APA’s relate to the cross-border transfer of tangible property.  Approximately 47% of APA cases in process relate to tangible personal property whereas cases involving tangible personal property and intra-group services represent approximately 31% and 22% of cases in process;
• The transactional net margin method (“TNMM”) continues to be the most frequently used transfer pricing methodology in APA cases; and
• APAs involving the United States represent approximately 71% of all APA cases that are in process (which is slightly lower than the percentage of completed APA cases that involve the United States).

Earlier this month, the Tax Executives Institute, Inc. (TEI) raised a number of important income tax administration issues in its annual meeting with the Canada Revenue Agency. Concerns were expressed about how the CRA conducts and manages large file audits (including the role of the Large File Case Manager or LFCM) as well as the design and development of the CRA’s new risk-based audit process for large businesses.

The agenda for those meetings (which also included the Department of Finance) is here.  TEI plans to publish CRA’s responses as soon as they are released.  The questions and concerns dealing with the audit process in particular are set out below.

7. CRA Audit Practices — Taxpayer Field Experience

CRA and large taxpayers share a common interest and goals in promoting a smooth and efficient audit. The goals include:

• Ensuring that audits are current;

• Avoiding the use of waivers to extend the audit period unnecessarily or habitually;

• Focusing audit queries on high-risk compliance issues;

• Using accepted audit sampling procedures to expand stretched resources;

• Maintaining transparency in decision-making and the determination of tax positions;

• Promoting timely, consistent, and effective issue resolution;

• Deploying human resources as effectively as possible; and

• Maximizing cost controls.

Over the course of the last several years, CRA has developed new audit approaches based upon an enhanced relationship with large taxpayers and a risk-based audit approach. TEI supports CRA’s new audit approach not only because of the common interest and shared goal of promoting efficiency, but because it promotes certainty of tax treatment sooner. That said, many large taxpayers have experienced behaviours seemingly at odds with the shared interests and goals. Examples include:

a) LFCMs are declining to discuss issues (or assert control over certain issues), saying they lack authority to make a decision in respect of subject matter. This suggests that issue resolution may be increasingly managed by CRA Headquarters in Ottawa as opposed to the TSOs. TEI believes that the objectives identified above can be advanced only if the LFCM is empowered to make decisions on issues and taxpayers are able to communicate directly with the decision-makers.

b) Auditors are asking for information on behalf of an undisclosed CRA source or seeking opinions or advice from CRA Headquarters without communicating the issue to the taxpayer or informing the taxpayer of the request. Where an opinion or advice is solicited, the TSO is generally bound by the Headquarters decision even though the taxpayer had little or no input into the development of the facts upon which the opinion is based.

c) Many auditors and LFCMs assert that they have no jurisdiction over specialty areas (e.g., SR&ED, International or Tax Avoidance matters). Thus, there seems to be no overriding coordinator or decision-maker.

d) The scope and nature of the tax treatment of items seem to change dramatically from previous years (i.e., fewer adjustments are proposed, but high-level conceptual challenges to a taxpayer’s filing position are asserted with minimal or no apparent technical analysis). Examples include challenges to reclassify amounts long treated (and frequently reviewed) as current expenses into capital items or challenges to the longstanding (and frequently reviewed) classification of capital items into longer-lived capital asset pools.

e) Adjustments are proposed without discussion or explanation of the technical position despite requests for the rationale, which leaves taxpayers questioning the quality of the audit or propriety of the asserted position. Without discussion, the position can seem arbitrary, and may be a consequence of the Tax Earned by Auditor (TEBA) metric.

f) Information requests or proposals for adjustments are submitted shortly before a taxation year becomes statute barred.

g) Certain audit queries seem intended to audit the taxpayer’s financial statements rather than the tax returns (e.g., there are instances where an auditor is verifying account balances in audited financial statements rather than trying to understand the adjustments on the tax returns to the financial accounts and the rationale for the adjustments).

h) Requests are made for significant amounts of data as opposed to relying on sampling where practical (e.g., requests for all professional fee invoices). In addition, information requests require taxpayers to produce enormous amounts of data within an abbreviated time frame. Response times should be reasonable and proportional to the volume of information requested.

i) Some auditors have refused to make taxpayer-favourable consequential changes and adjustments in subsequent years, even where the changes flow directly from an accepted audit adjustment to an earlier period. Instead, taxpayers are compelled to file amended returns to claim the consequential adjustments.

In addition to a general discussion of the member perceptions of audit behaviours and whether those behaviours are counterproductive to the shared goals of expeditious audits, transparency, and an enhanced relationship, TEI invites a discussion of the following:

a) In connection with the new risk-based audit approach, have quality control reviews been performed on the audit files since the approach was adopted? If not, will the quality control review be conducted on all files or all files above a certain size? Will new roles be created within CRA to conduct the quality control reviews independently of the field auditors?

b) Can CRA confirm whether the TEBA metric has been eliminated, as announced at the May 2012 TEI Annual Conference? If so, what measures will the Agency employ internally and for reporting its activities to other parts of the Government (e.g., Finance, Parliament, and the Auditor General)?

c) What other changes are being implemented at Headquarters and the TSOs to support the risk-based audit initiative?

*  *  *

12. Risk-based Audit Process

In 2011 CRA announced it was instituting a risk-based approach to audits whereby CRA would meet with senior representatives of the taxpayer to:

• Explain the redefined risk-based approach to large business compliance and how the approach affects taxpayers;

• Share CRA’s findings and observations noted during the taxpayer’s risk assessment; and

• Understand how the taxpayer manages tax risk at its highest governance levels.

With the first round of meetings with taxpayers complete, TEI has the following questions in respect of the approach:

a) Would CRA share its general observations, findings, trends, or conclusions with respect to the state of tax-risk governance?

b) In the interests of transparency, will CRA consider publishing a document outlining and discussing its review and risk-assessment process?

c) Has the first round of meetings with taxpayers led CRA to consider changes to its risk-assessment process and will it publicly announce the changes? Will affected taxpayers be apprised of changes to the scope of the risk-management approach that apply to their cases?

d) Will CRA review the risk assessment with the affected taxpayer, including discussing the criteria and factors used to determine a taxpayer’s risk rating? If a taxpayer disagrees with its risk-assessment rating, what steps can it take to address its concerns?

e) Assuming a taxpayer’s risk profile can change over time, will CRA revisit its risk-assessment ratings on a regular basis? If so, how often will the assessment be revised? Will CRA meet again with the taxpayer’s senior executives to review the revised rating?

f) Can CRA provide any details about the factors affecting a taxpayer’s risk rating?

g) Will CRA inform other tax jurisdictions (provincial or foreign) of its findings in respect of a taxpayer’s risk rating?

h) What guidance has been provided to the TSOs to ensure that the objectives of the new audit approach are applied consistently by all the TSOs?

In Noran West Developments Ltd. v. The Queen, the Tax Court of Canada (Justice Brent Paris) upheld the validity of a taxpayer’s waiver of its right to appeal executed following the conclusion of a settlement with the Appeals Division of the Canada Revenue Agency (the “CRA”).  This conclusion was reached, and the Crown’s motion to quash granted, notwithstanding the taxpayer’s valiant attempts to set aside the agreement.

The relevant statutory provision in subsection 169(2.2) of the Income Tax Act:

Waived issues

(2.2) Notwithstanding subsections 169(1) and 169(2), for greater certainty a taxpayer may not appeal to the Tax Court of Canada to have an assessment under this Part vacated or varied in respect of an issue for which the right of objection or appeal has been waived in writing by the taxpayer.

By way of background, the CRA audited a corporate taxpayer (the Appellant) in respect of unreported income from a condominium joint venture which engaged in certain non-arm’s length dispositions.  The auditor reassessed to (a) include $640,000 in the taxpayer’s income for its 2005 taxation year (on the basis of a valuation of the relevant condominium units), (b) recognize a shareholder benefit to the taxpayer’s sole shareholder and (c) apply gross negligence penalties under subsection 163(2) of the Income Tax Act in respect of both reassessments.

The taxpayer filed a notice of objection objecting to the inclusion of the $640,000 in its income (on the basis that the CRA’s valuation was wrong) and the assessment of a subsection 163(2) penalty.  The taxpayer’s sole shareholder filed no objection against his own reassessment.

Following discussions with the taxpayer’s representative, the Appeals Officer offered to settle the matter by (a) reducing the income inclusion by $50,000 (on the basis of a reduced valuation of the relevant condominium units) and (b) reducing the amount of the subsection 163(2) penalty accordingly.  The Appeals Officer sent a standard waiver letter which was signed by the taxpayer’s sole shareholder on behalf of the taxpayer.  It included the usual language in which the signatory attests that he or she is ”familiar with subsection 165(1.2) and 169(2.2) of the Income Tax Act and understand that I will be precluded from filing an objection or an appeal with respect to those issues.”

The CRA reassessed to implement the settlement, but the taxpayer filed an appeal in Tax Court in response.  The Crown moved to quash the appeal on the basis that the taxpayer had waived its right to appeal under subsection 169(2.2) of the Income Tax Act.  In answer to the motion counsel for the taxpayer advanced six arguments, none of which were successful:

1. The waiver agreement was not “in writing” as required by subsection 169(2.2) as the Appeals Officer omitted the taxpayer’s name.

The Tax Court judge concluded that “waived in writing” simply “requires that a waiver be reduced to writing as opposed to one given orally” and proceeded to find that the waiver agreement could not reasonably be read as applying to anyone other than the taxpayer.

2. The waiver agreement is unenforceable as the reassessment contemplated by that agreement would not have been consistent with the facts and the law.

The Tax Court judge found that there were errors in the first reassessment (the one that was settled).  However, the reassessment before the Court was the second reassessment (the one issued as a result of the waiver agreement).  As the second reassessment simply reduced the taxpayer’s income by $50,000 and reduced the subsection 163(2) penalty accordingly, there was no question that such a reassessment is within the CRA’s power.

3. The waiver agreement is invalid because the parties were not ad idem as to the terms of the agreement.  

First, it was said that the taxpayer’s sole shareholder believed that the waiver agreement applied to three taxpayers, not just one.  Therefore, there was no “meeting of the minds”.  Unfortunately for the taxpayer, the judge found that that belief, on the evidence, was “highly unlikely”.  In addition, an adverse inference was drawn from the failure of the taxpayer’s representative to give any evidence at all about what happened at the appeals stage.  The judge also rejected the contention that the sole shareholder believed that issue of beneficial ownership of the condominium units wasn’t covered by the waiver agreement and, therefore, there was no consensus ad idem.  There was no ”beneficial ownership” issue raised in the Notice of Objection, so there could be no reasonable expectation that it would have been reflected in the agreement.  The taxpayer’s final contention was that the sole shareholder did not believe that the waiver agreement dealt with the subsection 163(2) penalty.  As the text of the agreement dealt with the penalty, Justice Paris concluded that:

[61] . . . [i]f a party chooses not to read an agreement with care before signing it, or chooses to skip reading parts of it, I fail to see how he can turn around and allege that his intention did not accord with the written agreement. It must be presumed that, in those circumstances, the party intended to accept the agreement as written.

4. The agreement was vitiated by the CRA as it did not satisfy the terms of the waiver agreement because the subsection 163(2) penalty was incorrectly calculated on the second reassessment. 

Here is the error:

[24]  The respondent’s counsel concedes that an error was made in calculating the amount of the gross negligence penalty in the [second] reassessment and that the penalty was based on unreported income in the amount of $599,760 rather than on $589,760, as agreed. The respondent concedes that the penalty was too high by as much as $1,106. Because this error was only raised by Noran’s counsel shortly before the hearing of the motion, counsel for the respondent advised the Court that she was unable to obtain the exact amount of the error.

The Tax Court judge found himself unable to agree with the proposition that:

[65] . . . any inconsistency between the reassessment and the waiver agreement allows a taxpayer to appeal any aspect of the reassessment as if no waiver had been given.  It does not make sense that any error in reassessing, however minor, could permit a taxpayer to repudiate the waiver entirely.

5. The Tax Court should decline to enforce the waiver agreement on the basis that it is unconscionable. 

This argument was not pressed strongly.  In any event, the judge could find no evidence to support it.

6. The taxpayer is appealing issues other than those dealt with in the waiver agreement. 

This argument was based on the sole shareholder’s belief about what was covered by the agreement (which was rather narrow) rather than the text of the agreement itself.  Justice Paris rejected reliance on subjective belief and concluded that a “reasonable person” standard must be applied:

[74]  When searching for the intentions of the parties, I believe that the search for intention in the case of a waiver is to be conducted in the same manner as for any contract on the basis of the parties’ manifested intention. That intention is determined from the perspective of the objective reasonable bystander. Fridman in the Law of Contract in Canada, refers to the classical formulation of this notion in Smith v. Hughes:

If whatever a man’s real intention may be, he so conducts himself that a reasonable man would believe that he was assenting to the terms proposed by the other party and that other party upon that belief enters into a contract with him, the man thus conducting himself would be equally bound as if he had intended to agree to the other party’s terms.

*  *  *

Underlying this decision is a clear public policy that negotiated settlements, as a general matter, ought to be upheld:

[45] . . . The desirability of upholding negotiated settlements was discussed by Bowie J. in 1390758 Ontario Corp v. The Queen: 

[35] I agree with Bowman C.J. and the authors Hogg, Magee and Li that there are sound policy reasons to uphold negotiated settlements of tax disputes freely arrived at between taxpayers and the Minister’s representatives. The addition of subsection 169(3) to the Act in 1994 is recognition by Parliament of that. It is not for the Courts to purport to review the propriety of such settlements. That task properly belongs to the Auditor General.

[36] The reality is that tax disputes are settled every day in this country. If they were not, and every difference had to be litigated to judgment, unmanageable backlogs would quickly accumulate and the system would break down.

[37] The Crown settles tort and contract claims brought by and against it on a regular basis. There is no reason why it should not settle tax disputes as well. Both sides of a dispute are entitled to know that if they invest the time and effort required to negotiate a settlement, then their agreement will bind both parties.

Although the taxpayer was unsuccessful, this decision is ultimately reassuring as the same principle applies to the government - if the CRA attempts to resile from a settlement agreement it too will be confronted by the same underlying public policy, namely, that negotiated settlements of tax disputes should be respected.

Under proposed 237.3 of the Income Tax Act, a “reportable transaction” is an avoidance transaction that has two of three “hallmarks” (fee hallmark, confidential protection hallmark, or contractual protection hallmark). For a brief summary of proposed s. 237.3, see “Tax Avoidance Transaction Reporting” by Brian Carr and Zahra Nurmohamed in Resource Sector Taxation (vol. VIII, no. 1).

Following release of the draft legislation, many tax advisors were concerned that the definition of “confidential protection” was too broad. In response, the recent Technical Notes on proposed s. 237.3 released by the Department of Finance offer the following interpretation:

Based on the definition “confidential protection”, the circumstances described in paragraph (b) of the definition “reportable transaction” would exist in respect of an avoidance transaction or series of transactions that includes the avoidance transaction if an advisor or promoter in respect of the transaction or series obtains or obtained anything that would prohibit the disclosure to any person or to the Minister of details or the structure of the avoidance transaction or series that includes the avoidance transaction under which a tax benefit could result. This is in contrast to a situation in which a client of an advisor benefits from the existence of solicitor-client privilege in respect of information regarding the avoidance transaction or series of transactions, and which would not give rise to a “hallmark” in respect of the avoidance transaction or series. See the explanatory notes accompanying new subsection 237.3(11) for further details about solicitor-client privilege in the context of new section 237.3.

It appears that the Department of Finance believes that the existence of solicitor-client privilege is not “confidential protection” for the purposes of s. 237.3, though a literal reading of the definition of “confidential protection” does not appear to draw this distinction.

Are the Technical Notes on this issue sufficient comfort for tax advisors? Is this the last statement from the Department of Finance on the subject? Stay tuned for further developments.

At today’s Canada Revenue Agency Toronto Centre Tax Professionals Group Breakfast Seminar (November 14, 2012), the CRA provided an update on a number of current audit issues.

The CRA was represented by Sal Tringali, Regional Technical Advisor of Aggressive Tax Planning, and James McNamara, Manager of International Taxation and Aggressive Tax Planning Audit Division from the Toronto Centre Tax Services Office. The discussion was moderated by Jacques Bernier (Baker McKenzie LLP) and Rachel Gervais (BDO Canada LLP).

The audit issues highlighted by the panel included the following:

GST/HST

1. Recapture input tax credit
2. ITC allocation % – mixed supplies
3. Financial services
4. Imported supplies
5. Reinsurance/loading
6. Loyalty reward points
7. VDP – Related parties

Income Tax

Additionally, the CRA made the following comments:

• The CRA’s access to/requests for accountants’ working papers remains a “hot topic”. Generally speaking, the CRA will first ask the taxpayer for information/documents, after which the CRA may request information/documents from the taxpayer’s accountants. The CRA’s objective is to perform high-quality audits, and access to complete information is required to do so.

• The CRA reminded taxpayers of its recent announcement that the CRA will not assess a taxpayer’s return where the taxpayer has claimed a charitable donation and the alleged gift is made as part of a donation arrangement. The delay in assessing the return could be two years or more (see Jamie Golombek’s recent article on the subject).

• The CRA is considering a variety of provisions that may be applied where the taxpayer has used a structure to divert business income to RRSPs through trusts and partnership interests held by shareholders or key employees. (See also the CRA’s announcement at the Canadian Tax Foundation’s 2012 Ontario Tax Conference, at which the CRA stated that it may apply s. 56(2) to the actions of a trustee.)

• The CRA has appealed the Tax Court’s decision in Guindon v. The Queen to the Federal Court of Appeal. In light of the Tax Court’s decision, the CRA is currently considering its options in respect of the assessment of third party penalties.

• The CRA has considered the application of third party penalties in 185 cases. In 71 of those cases the penalty was applied, resulting in the imposition of $79 million of penalties. In 50 cases the penalty was not applied, and 64 cases are ongoing.

• The CRA will continue to revoke e-file privileges where a tax preparer is subject to a penalty, even where a penalty against a single tax preparer may result in the revocation for his or her entire firm.

• The CRA referred to the recent Supreme Court decision in GlaxoSmithKline v. The Queen and stated that it intends to follow the new OECD guidelines on transfer pricing and the hierarchy of pricing methods. The CRA said that it did not expect to release any formal communication to the public on this issue, but Information Circular IC 87-2R “International Transfer Pricing” may be updated to reflect this position.

UPDATE: After the seminar, the CRA informed us that it intends to follow the guidance in the recently updated OECD Guidelines and will be issuing a Transfer Pricing Memoranda (TPM) on the matter to the public. This TPM will reflect a recently released internal Communique on the same subject and will be made available in the near future.

• The CRA clarified that Tax Earned By Audit (“TEBA”) remains a metric for measuring ”tax at risk”, but it is not used to measure the performance of an auditor. Rather, the CRA measures the performance of auditors based on six major elements: (i) planning the audit, (ii) conducting the audit, (iii) applying the appropriate legislation/policy, (iv) the end product of the audit, (v) professionalism in the audit, and (vi) timeliness of completion of the audit.

• The CRA plans to convene face-to-face meetings with approximately 160 large businesses (i.e., annual sales over $250 million) as part of the CRA’s large business audit project. The CRA will continue to risk-assess all large businesses/entities annually.

• The CRA intends to clear a backlog of approximately 1,300 audit files so that it may assess the most recent taxation year and the immediately preceding taxation year for most businesses by 2015-16.

• The CRA reiterated that issues that arise during the audit process should be raised with the auditor, after which it may be appropriate to involve the auditor’s team leader. If the issue cannot be resolved at that level, it would be appropriate to raise the issue with the auditor’s manager or the assistant director of audit at the particular TSO.

Two appeals will be heard tomorrow morning by the Supreme Court of Canada in rectification decisions from the Quebec courts. The first appeal is Agence du Revenu du Québec (formerly the Deputy Minister of Revenue of Quebec) v. Services Environnementaux AES Inc., et al. while the second appeal is Agence du Revenu du Québec v. Jean Riopel, et al.  In each case, the Quebec Court of Appeal agreed with the taxpayers that rectification was in order.

The Supreme Court’s summary of the first appeal may be found here.  Each factum in the first appeal may be read here.

The Supreme Court’s summary of the second appeal may be found here.  Each factum in the second appeal may be read here.

The decision of the Quebec Court of Appeal in the first appeal is here.  The decision of the Quebec Court of Appeal in the second appeal is here.

At 9:30 a.m. tomorrow, the live webcast of the hearings may be viewed here or here.  The archived webcast will be available for viewing a day or two later.

The newest member of the Supreme Court of Canada, Justice Richard Wagner, was a member of the panel of the Quebec Court of Appeal that decided the second appeal.  He will, therefore, not hear tomorrow’s appeals.  Accordingly, a maximum of seven judges will be on the panel tomorrow morning.

Postscript: At the conclusion of the hearing, the panel reserved judgment.  During the course of the hearing, highlights of argument were tweeted live @CanTaxLit

At the Canadian Tax Foundation’s recent Ontario Tax Conference (October 29-30), the Canada Revenue Agency provided an update on its current audit priorities and activities as part of the conference’s “Tax Administration Panel“.

The CRA was represented by Fiona Harrison, Manager of the Resources Section at the CRA’s Income Tax Rulings Directorate, and Jeff Sadrian, National Director of the CRA’s Large Business Audit Programs.

In the course of the presentation, the CRA discussed a variety of issues (see the “Tax Administration Panel” conference slides), including “red tape” reduction, the CRA’s trust audit project, Regulation 105 waivers, ABIL claims, and omission penalties under s. 163(1). The CRA confirmed that it determines audit priorities based on the “highest risk”, and that it is continuing its “intelligence-based risk assessment” of taxpayers to determine which files will be selected for audit.

Other highlights included:

• Folios – The CRA considers many existing Interpretation Bulletins to be out of date. The CRA intends to reorganize the information in the existing publications in new Folio chapters (i.e., all information relating to specific subjects will be “grouped” together). The CRA plans to update the Folios on an on-going basis, and the first 10-12 Folio chapters are likely to be published before the end of 2012.
• Entity Classification - In a reversal of an earlier position (see, for example, CRA Document No. 2011-0415141E5 “Tax status of a German Family Trust” (August 4, 2011)), the CRA will once again accept requests for rulings on the classification of foreign entities.
• Inter-Provincial Trusts – Where a trust claims to be resident, and pays tax, in one province, and the trust is later reassessed as resident in another province, the CRA will reassess the trust only for the difference between the tax paid in the first province and the tax owing in the second province.
• U.S. LLCs – The CRA continues to disagree with the Tax Court’s decision in TD Securities (USA) LLC. v. The Queen (2010 TCC 186). The CRA’s view is that a fiscally-transparent U.S. LLC does not qualify as a resident of the U.S. for the purposes of the Canada-U.S. Tax Treaty, and is not a “qualifying person” under Article XXIX-A of the Treaty.
• Section 56(2) – The CRA stated that it is aware of “elaborate arrangements” utilized to divert business income to family members. The CRA stated that, where such arrangements include the use of a trust, section 56(2) may be applied in respect of distributions from the trust provided the requirements of the provision are otherwise met (see Neuman v. The Queen (98 D.T.C. 6297 (S.C.C.)). In other words, the CRA may apply s. 56(2) to the actions of a trustee.

(The Tax Administration Panel conference slides are republished with permission of the Canadian Tax Foundation.)

In Worsfold v. The Queen (2012 FC 644), the Federal Court held that a taxpayer’s disclosure under the Voluntary Disclosures Program (the “VDP”) was “voluntary”, even though the Canada Revenue Agency (the “CRA”) had commenced enforcement action against a related party. Worsfold confirms that a link between the enforcement action and the disclosed information is what is important — not a link between the parties — when considering whether a disclosure made alongside an existing enforcement action is voluntary. Also, given that the sequence of events was integral to the findings in this case, this decision underscores the importance of keeping detailed records at every stage of a voluntary disclosure.

To read the full article, please click here.

In order to administer and enforce the self-reporting system of tax assessment in Canada, the Income Tax Act (ITA) and Excise Tax Act (ETA) provide the CRA with the power to demand certain information from taxpayers. Generally, this information is collected for the purposes of auditing a taxpayer, but may also be obtained where no audit is conducted. For example, the CRA may access such information for the purpose of evaluating whether record-keeping requirements have been complied with. Higher statutory thresholds are imposed on the CRA – such as requiring a search warrant issued by a judge – where the information sought would not normally be required for an audit.

Despite the broad statutory powers conferred on the CRA to ensure compliance, the courts are wary of the potential for abuse and have been careful to circumscribe their application. In James Richardson & Sons v. M.N.R., the Supreme Court of Canada clarified that when requiring the production of documentation there must be a “genuine and serious inquiry” into the tax liability of a specific taxpayer (or taxpayers). Richardson was decided in the context of what is now section 231.2 of the ITA, which requires taxpayers to provide documents or information to the CRA for the enforcement or administration of the Act. In its recent decision in R. v. He, the British Columbia Court of Appeal confirmed that the same principle should be applied to section 231.1 of the ITA (and the corresponding section 288 of the ETA) when inspecting records at the taxpayer’s place of business.

R. v. He concerned a CRA program called the Electronic Records Evaluation Pilot Project (“ERE”) that targeted specific businesses for research purposes – including restaurants, convenience stores and small supermarkets – to evaluate their record-keeping compliance. One business chosen for the program was the restaurant, Sushi Man, run by the He family in Vancouver. Although the initial contact by the CRA indicated that its review would not be an audit, certain inconsistencies were found that led to an audit, investigation and, ultimately, criminal charges. Apparently, CRA thought that Sushi Man had been using some form of sales suppression software (known as a “zapper”) to erase the record of certain transactions and thereby evade taxes. The taxpayer alleged that the CRA’s real purpose was to conduct a criminal investigation into establishments using the zapper software and, therefore, it had strayed outside the scope of section 231 of the ITA (and 288 of the ETA) thereby violating his right against unreasonable search and seizure under section 8 of the Canadian Charter of Rights and Freedoms.

The issue before the courts was whether, under the circumstances, the CRA was entitled to seize information from Sushi Man under section 231.1 of the ITA and 288 of the ETA. The Provincial Court Judge found that there had been no “genuine and serious” inquiry into that taxpayer’s tax liability and concluded that the seizure of information by the CRA was unlawful, implying that the ERE program had been used improperly for an undercover investigation into restaurants using zappers. On appeal, both the Supreme Court of British Columbia and the British Columbia Court of Appeal agreed with the Provincial Court that the rule established in Richardson should be applied to section 231.1 of the ITA (and by extension to section 288 of the ETA).

Writing for the Court of Appeal, Justice Hinkson remarked as follows:

[54] In my opinion, s. 231.1 of the ITA, if interpreted too broadly, is open to that same possibility of abuse. It and its parallel section in the ETA permit the same broad authority to the CRA as does  s. 231.2 and its parallel section in the ETA. Further, as discussed by the appeal judge, s. 231.1 allows for a more intrusive power than that permitted under s. 231.2. It is my opinion that the correct interpretation of s. 231.1 requires that the reasoning in Richardson must therefore be applied to that section.

With respect to the conduct of the CRA investigation, Justice Hinkson deferred to the Provincial Court Judge’s conclusion that the ERE’s true purpose was not to review books and records nor to audit the individual businesses selected. Therefore, the seizure of information was not permissible under section 231.1 of the ITA (or section 288 of the ETA).

While it is not yet certain whether the Crown will seek leave to appeal to the Supreme Court of Canada (no leave application has been filed at the time of this post), it seems clear that unless it has secured prior judicial authorization, the CRA cannot obtain information from a taxpayer in the absence of a “genuine and serious” inquiry into the taxpayer’s tax liability.

Reuters recently reported a study showing that corporations face very long odds in tax appeals heard by the United States Supreme Court. There were 919 income tax cases in the Supreme Court of the United States from 1909 to 2011. 364 of those cases involved corporations. In “abuse” cases, the government won 61% of the time. In other cases, the government won 68% of the time. The real story is likely much grimmer since the statistics show that the US Supreme Court only grants review in about 2% of leave applications.

The Canadian Supreme Court heard 356 income tax cases between 1920 and 2003. Of these, the statistics show that the government won 223, or roughly 2/3. The record of Supreme Court tax cases between 2004 and 2012 is essentially similar. While an exact breakdown of corporate cases is not available, anecdotal evidence suggests that the success rate of corporations is roughly 1/3 (a more detailed analysis will be available in the future).

While the Canadian experience appears superficially to mirror the American statistics, a very different story is disclosed by Canadian leave to appeal statistics.

As the chart demonstrates, roughly 12% of leave applications are granted in Canada. Thus, corporations and other taxpayers may have as high as 6 times more likelihood of success in a tax appeal before the Supreme Court of Canada than in cases before the Supreme Court of the United States.

Typically, a simple informal request by a taxpayer to the CRA for copies of the T20 Audit Report, T401 Appeals Report or other documents will result in disclosure of those documents. However, sometimes these informal requests are met with resistance.

Assuming that there is no issue regarding the disclosure of taxpayer information under section 241 of the Income Tax Act, there are few reasons, if any, for the CRA not to provide these documents to a taxpayer upon an informal request.

In fact, the CRA has published CRA Document P148 “Resolving Your Dispute: Objection and Appeal Rights under the Income Tax Act” (2009), which lists the records available to taxpayers, including audit reports and working papers; scientific, appraisal and valuation reports; records of discussions between auditors and appeals officers; and others.

Additionally, the CRA recently published the answer it provided at the 2011 STEP Conference in response to a question about obtaining information and documents in the possession of the CRA (see CRA Document 2011-0403751C6 “2011 STEP Conference – Q8 – Access to Information” (June 2-3, 2011)).

In short, the CRA stated that its Access to Information and Privacy (ATIP) Directorate promotes and encourages informal disclosure of documents by the CRA. The formal request procedures under the Access to Information Act (ATIA) and the Privacy Act (PA) are intended to complement and not replace existing procedures for access to government and personal information. The CRA stated that documents or reports created by an auditor or appeals officer should be given to the taxpayer without requiring the taxpayer to make a formal request under the ATIA and PA.

This is a helpful published position that should be referred to by the taxpayer if he/she is encounters resistance on an informal request for information/documents in the CRA’s possession.

Tax law geeks call it “form over substance” – how Canadians are taxed on their actual relationships and transactions rather than what they intended those to be.

However, mistakes can be made – and sometimes the tax assessed is not reflective of the true nature of the situation at hand.

In the March 16, 2012 issue of The Lawyers Weekly, I discuss the ways in which mistakes may be fixed so as to avoid unintended and adverse tax consequences.

On November 21, 2011, the Canada Revenue Agency (CRA) issued a news release entitled “Taxpayer relief deadline is December 31, 2011“, which confirms that it formally accepts the interpretation of the 10-year limitation period for interest relief established by the Federal Court of Appeal in Bozzer v. Canada.

Before the Federal Court of Appeal decision in Bozzer, the CRA took the position that the Minister may exercise his discretion to cancel or waive interest otherwise payable under the Income Tax Act only if a taxpayer applies within 10 calendar years of the end of the taxation year in which the underlying tax debt arose. The Federal Court of Appeal in Bozzer held, however, that the Minister’s discretion allows for the cancellation or waiver of interest that accrues during the 10 calendar years preceding the calendar year in which the request for relief is made, regardless of the year in which the tax debt arose.

Although the Bozzer decision dealt with the interpretation of the 10-year limitation period for interest relief requests in the context of the Income Tax Act, the CRA confirmed in its November 21, 2011 news release that the 10-year limitation period will be interpreted in the same manner with respect to interest relief applications made under the Excise Tax Act, the Air Travellers Security Charge Act, the Softwood Lumber Products Export Charge Act, 2006, and the Excise Act, 2001.

Although the Crown did not seek leave to appeal the decision of the Federal Court of Appeal to the Supreme Court of Canada, it was unclear whether the CRA would actually follow and apply the FCA decision across the board.  For this reason, the news release is most welcome.

[Note: The author, along with David Spiro of Fraser Milner Casgrain LLP, acted as counsel for Mr. Bozzer in the Federal Court of Appeal - Ed.]

The decision of the Federal Court in Minister of National Revenue v. RBC Life Insurance Company et al., 2011 FC 1249 may have opened the door to new opportunities for judicial review in the context of ex parte orders in federal tax matters only days after the decision of the Federal Court of Appeal in Stemijon Investments Ltd. v. Attorney General of Canada (see our earlier post) appeared to have narrowed those opportunities in the context of so-called “fairness applications” dealing with late-filed forms under federal tax statutes.

By way of background, the case concerned insurance products known in the industry as 10-8 plans. These essentially were a tax-effective insurance structure where, in very general terms, the taxpayer paid a high rate of deductible interest on loans in connection with insurance products where relatively high rates of interest accrued free of tax. The Canada Revenue Agency was aware of these structures at the highest levels and the record disclosed that they had considerable concern that the structures were abusive, violated GAAR, etc. As a result, CRA made ex parte applications under subsection 231.2(3) of the Income Tax Act against a number of the issuers of such 10-8 plans requiring the production of detailed information about these plans and their customers.

What CRA did not disclose to the Court on these ex parte applications was that one of the principal purposes of these applications was to take measures to “chill” 10-8 plan business. This offended the Court:

[58] At the hearing, the Insurers conceded that the Minister had a valid audit purpose in issuing the requirements, but argued that this valid purpose was extraneous to her primary goal, which was to chill their 10-8 plan business. I agree.

[59] I do not believe that the Minister’s central purpose in issuing the requirements is sufficiently tied to her valid audit purpose. Contrary to the Minister’s pretension, I did find evidence that the targeted audit of specific 10-8 plan holders was not only done to test the reasonableness of the 10% payable interest rate or the possible application of the GAAR but to send a message to the industry. I am not satisfied that the Minister’s attempt to “send a message” is a valid enforcement purpose such that subsection 231.2(3)(b) of the Act is satisfied or that this goal is sufficiently connected to the Minister’s valid audit purpose.

Accordingly, Justice Tremblay-Lamer cancelled the earlier ex parte orders with costs.

The Federal Court’s decision is a refreshing affirmation of the Crown’s duty of fairness and candour, particularly in ex parte proceedings. The decision should encourage those in receipt of “unnamed persons” requirements to challenge such requirements with a view to ascertaining whether the facts put forward by the CRA on the ex parte application to obtain the order constituted a “full and frank” disclosure of all the relevant facts.