Recent case law confirms the tax authorities have broad but not unlimited powers, writes John Sorensen
Recent case law (BP Canada, 2017 FCA 61 and Cameco, 2019 FCA 67) has helped clarify the scope of the Canada Revenue Agency’s audit powers. The CRA accordingly updated its guidance in Communiqué AD-19-02R this June. BP and Cameco were “compliance order” cases under s. 231.7 of the Income Tax Act. Compliance orders are sought by CRA in the Federal Court to force taxpayers to comply with CRA audit activity.
In BP, the CRA sought the taxpayer’s analysis of its “uncertain tax positions,” or UTPs, being conclusions BP reached concerning the likely outcome of a CRA challenge — recorded in so-called “tax accrual workpapers,” or TAWPs. Such analysis of weaknesses in tax filings obviously provides the CRA with an audit roadmap. The issue for publicly traded taxpayers like BP is that they are required to prepare audited financials and reserve for contingent liabilities, including UTPs.
The Federal Court of Appeal noted that CRA concerns about “tax at risk” had been allayed without the TAWPs; therefore, the compliance order application was brought just to prove the CRA could have any documents without restrictions or justification. While the ITA’s audit provisions are broad and CRA auditors are entitled to reasonable assistance, that does not mean a taxpayer’s tax analysis can be conscripted against it (especially when the taxpayer is obliged to create that analysis) — nor can the CRA force a taxpayer to disgorge that kind of information without any justification.
In Cameco, the CRA sought to compel 25 employees to attend interviews and answer questions. Cameco refused, but they offered to answer in writing, leading to the compliance order application to force interviews. The Crown argued that the words "inspect, audit or examine" in paragraph 231.1(1)(a) allow the CRA to compel oral answers from a taxpayer, its employees or a foreign subsidiary’s employees.
The FCA rejected the Crown’s interpretation: Audit powers in paragraphs 231.1(1)(a) and (b) focus on information that is or should be in a taxpayer’s records, not extending to oral answers. Paragraph 231.1(1)(d) requires an owner, manager or other person on the premises to provide assistance and answer proper questions. Paragraph (d) puts paragraph (a) in context: Parliament meant for CRA auditors to have access to records, but there is no need for the taxpayer to be present because assistance can be provided by an owner, manager or someone at the premises.
The FCA judgment also noted that the CRA’s general audit powers were amended in 1986 to remove a power to compel oral answers. The FCA stated that while it may be important for the CRA to ask questions, that does not trump statutory language and the CRA has the power to fill in gaps with inferences and assumptions that would have to be proven wrong by the taxpayer on a balance of probabilities. Thus, the CRA is not significantly prejudiced when it cannot force interviews with corporate employees.
The CRA Communiqué provides guidance on CRA policy following BP and Cameco. The CRA’s position is that it must assess tax accurately and taxpayers must correspondingly disclose enough information to fulfil that purpose. CRA officers must seek information first from source records before other, indirect sources and may pressure the taxpayer or third parties where a transactional purpose is not ascertainable from taxpayer information (or if the taxpayer is unco-operative).
TAWPs may be sought if document requests accord with the Communiqué, including where they are relevant to audit items.
The Communiqué also recognizes that legal advice on UTPs is privileged but takes the position that the decision to include an amount in a tax reserve is not legal advice and the taxpayer’s UTP list is not privileged. The CRA does not view the disclosure of TAWPs as self-audit: The CRA would (supposedly) come to its own conclusions regarding a transaction’s tax treatment, uninfluenced by a taxpayer’s subjective analyses of the weaknesses in its filing position. Practitioners with CRA experience are unlikely to find the latter statement especially credible.
In Cameco, the Communiqué noted that taxpayers should fully co-operate with reasonable requests and added that Cameco does not mean that owners, managers or others at a business may refuse to co-operate. Thus, the CRA will continue to engage in discussions and interviews to expedite audits, and the CRA will exercise its power to make factual inferences and assumptions and to assess on that basis.
The appearance of obstruction is likely to result in a higher CRA risk profile and more intrusive auditing.
John Sorensen is a Toronto-based tax dispute resolution partner at Gowling WLG and leader of the firm’s national tax group.
