In early June, 2010, the Canada Revenue Agency ("CRA") released its long awaited administrative policy on gaining access to taxpayer information and documents. The policy reaffirms the CRA's position that is entitled to virtually unrestricted access to taxpayer's information and documents, subject only to solicitor-client and litigation privilege. As a result, obtaining tax advice from accountants, without involving tax lawyers, puts the confidentiality of the advice, and all of the related information and documents, in jeopardy.
The Income Tax Act (Canada) ("Act") requires taxpayers to maintain "books and records" to enable taxes payable to be ascertained and to determine other amounts that should have been deducted, withheld or collected. The Act also confers extremely broad powers on the CRA to access taxpayer information and documents, subject only to the protection of solicitor-client or litigation privilege.
The CRA first discussed its intention to draft an administrative policy on access to taxpayer information and documents at the Canadian Tax Foundation national conference in 2004 and periodically updated the tax community on the progress of the policy. As early as 2004, the Canadian Institute of Chartered Accountants ("CICA") wrote to the Minister of National Revenue ("Minister") urging that CRA access to accountant's and auditor's working papers be restricted to "exceptional and well-defined circumstances", because untrammeled access would have a chilling effect on communications between taxpayers and their advisors. The CICA's position was that if the CRA can pry into taxpayers' private communications with their advisors, taxpayers will be reluctant to seek advice. This may deprive corporations and ultimately their shareholders of valuable advice, which jeopardizes the integrity of financial reporting, the audit function and corporate governance.
The New Policy
A pre-publication draft of the new CRA policy was released for comments in late 2008. Unfortunately, the most troubling proposals in the draft remain in the final policy. For example, both the draft and final policies state that CRA personnel are authorized to request relevant documents during an inspection, audit or examination for any purpose related to administering or enforcing fiscal statutes, where "any purpose" includes "acquiring information for the purpose of substantiating the taxpayer's position on a specific issue, and identifying audit issues and concerns with regards to tax at risk."
Further, both versions of the policy state that CRA officials are authorized to inspect, audit, review or examine both "the books and records of a taxpayer" and any document of the taxpayer or any other person that relates or may relate to the information in a taxpayer's books and records. The phrase "any document" includes accountants' and auditors' working papers, including "working papers created by or for an independent auditor or accountant in connection with an audit or review engagement, advice papers, and tax accrual working papers (including those that relate to reserves for current, future, potential or contingent tax liabilities)." Tax accrual workpapers are essentially a roadmap through all of the "soft spots" in a taxpayer's tax return, prepared for the purpose of calculating reserves for uncertain tax filing positions. In the draft version of the policy, the CRA acknowledged that tax accrual workpapers may be requested by auditors to expedite the audit and focus the examination on the most significant issues. Although this language does not appear in the final version, it is obvious that the reason any tax authority seeks to obtain tax accrual workpapers is to have a guided tour of the taxpayer's tax planning.
The draft and final CRA policy both state that "since accountants' and auditors' working papers relate to a taxpayer's books and records, they may be necessary, although not routinely required, in the determination of a taxpayer's liabilities and entitlements." This suggests that the CRA may show some restraint in requesting working papers and may begin an audit by reviewing source documents, rather than directly targeting working papers including tax accrual workpapers.
The annex to the new CRA policy reviews the specific tools the CRA can deploy to obtain taxpayer information and documents. The summaries of law in the annex are mostly non-contentious. Under the heading "Privileged Communications", the CRA correctly confirms that it cannot compel materials to be produced that are subject to solicitor-client or litigation privilege and that solicitor-client privilege may extend to communications with third parties, where the third party is engaged as an agent of the client.
The annex to the new policy also states that a "record" is defined in ss. 248(1) of the Act and includes a "plan", among other items. The entire definition of "record" is non-exhaustive and "includes an account, an agreement, a book, a chart or table, a diagram, a form, an image, an invoice, a letter, a map, a memorandum, a plan, a return, a statement, a telegram, a voucher, and any other thing containing information, whether in writing or in any other form". It is unclear why the new CRA policy would specifically single out the word "plan" for particular mention, but accountants preparing tax "plans" clearly need to be wary.
The CRA's view that it is entitled to accountants' and auditors' working papers, including tax accrual workpapers, is flawed for a number of reasons.
First, as discussed above, the new policy may create a chilling effect on taxpayers seeking to obtain certain advice. If taxpayers become reluctant to seek the candid advice of professionals, this can only have a negative effect on the health of a business. For example, if a business does not maintain adequate reserves for contingent liabilities, including reserves for uncertain tax positions, a substantial reassessment could severely undermine the business. Therefore, in the interest of allowing businesses to obtain candid advice about uncertain tax positions, the CRA should refrain from prying tax accrual workpapers out of the hands of taxpayers and their advisors.
Second, it is unfair for the CRA to rely on working papers that include subjective opinions and evaluations of how the Act might apply. Notwithstanding the claim in the new CRA policy that "[o]fficials will be objective [and] will not be influenced by any subjective analyses, comments or opinions contained in the information or documentation reviewed", it is difficult to conceive how the CRA would not be influenced by the analysis, comments or opinions.
Third, workpapers including tax accrual workpapers are not necessary to ascertain tax. As noted above, s. 230 of the Act requires taxpayers to keep sufficient books and records to enable the Minister to ascertain tax payable. Since tax payable should generally be ascertainable from source documents there is no need for the CRA to obtain and rely on subjective analysis of tax provisions in workpapers. In exceptional circumstances, where source documents are lost or a transaction cannot be deciphered, tax accrual workpapers might be necessary and therefore justifiably requested by the CRA.
Although the annex to the new CRA policy summarizes the law more or less correctly, certain points in the summary of legal privilege are disturbing. First, the CRA states that communications between an in-house lawyer and a board of directors may not be privileged if the lawyer also provides services other than as a legal advisor. Although we must disagree with this assertion, it may be arguable that preparing tax accrual workpapers is an accounting exercise. Thus, to the extent an in-house lawyer assists in preparing workpapers, the CRA may take the position that privilege does not apply since the work is not legal work. Second, the annex unequivocally asserts that documents which have been disclosed to someone other than the solicitor and client are not privileged. This is not a correct statement of the law, since Canada has a doctrine of limited waiver of privilege, under which documents may be provided to parties outside the solicitor-client relationship for limited purposes, without waiving privilege to the CRA.
Protecting Taxpayer Documents Going Forward
It is well-established law that taxpayers have a low expectation of privacy in their books and records. It is also well-established that there is no privilege in communications between accounting professionals and their clients. Therefore, unless Canada enacts a statutory tax professional privilege regime, the only way to protect taxpayer documents and avoid disclosure to the CRA is through solicitor-client or litigation privilege. Taxpayers face significant risk of having their confidential tax analysis and advice forcibly produced to the CRA, if a solicitor is not involved in providing the tax advice.
The new CRA policy is not likely to be the last word on the scope of disclosure in an audit context, particularly as this relates to third party advisors. As of this writing, the PriceWaterhouseCoopers LLP v. M.N.R. case remains on the Federal Court docket and the Court recently granted the parties an extension of time to complete the next procedural steps. The case concerns the CRA's request for access to PwC's working papers for the Ford Group of Companies. PwC had refused to grant access to the working papers as the CRA's request contravened its own policy of restraint in requesting those documents. The CRA did not approach Ford first, but went straight to requesting information from PwC as the third party advisor, which would seem both unnecessary and not in accordance with the CRA's policy.
Taxpayers and their advisors need to be prepared to deal with the CRA's new policy on access to taxpayer documents. In our view, the most effective way to ensure that confidential tax advice is protected from disclosure to the CRA is to obtain that advice from or with the aid of legal counsel, so that it is privileged.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.