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.
For more information, visit our Canadian Tax Litigation blog at www.canadiantaxlitigation.com
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