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Canada Revenue Agency Provides Update on Strategic Direction and SR&ED

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.

Canada Revenue Agency Provides Update on Strategic Direction and SR&ED

CRA Releases New APA Report

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).

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CRA Releases New APA Report

Could solicitor-client privilege be a hallmark of a reportable transaction under proposed s. 273.3 of the Income Tax Act?

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.

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Could solicitor-client privilege be a hallmark of a reportable transaction under proposed s. 273.3 of the Income Tax Act?

When is Voluntary Disclosure Voluntary?

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.

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When is Voluntary Disclosure Voluntary?

From the intrusive to the abusive – what happens when the CRA goes too far?

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.

From the intrusive to the abusive – what happens when the CRA goes too far?

Reuters: Corporations Face Long Odds in Tax Cases Heard by the United States Supreme Court – Situation Brighter in Canada

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.

Year      Denied Granted
2001

579

79

2002

433

53

2003

523

75

2004

466

83

2005

492

65

2006

406

55

2007

550

69

2008

448

51

2009

444

59

2010

388

54

2011

398

62

Total

5127

705

     
Grand Total

5832

 
     
Average

0.120885

 

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.

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Reuters: Corporations Face Long Odds in Tax Cases Heard by the United States Supreme Court – Situation Brighter in Canada

Federal Court Cancels its Earlier Orders Authorizing Issuance of “Unnamed Persons” Requirements as Canada Revenue Agency Failed to Disclose all Relevant Facts

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.

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Federal Court Cancels its Earlier Orders Authorizing Issuance of “Unnamed Persons” Requirements as Canada Revenue Agency Failed to Disclose all Relevant Facts