The Canadian income tax system is based on the principles of self-reporting and self-assessment. At first instance, the government does not have sufficient information to determine each person’s income or tax. Accordingly, taxpayers are trusted to report their own income for each year. In order to ensure accuracy of returns, the Canada Customs and Revenue Agency ("CCRA") is given broad powers to audit taxpayers’ books and records and obtain other information.
To encourage honesty and integrity in filing returns, the Income Tax Act (the "Act") makes it a criminal offence for CCRA officials to disclose any taxpayer information which has been obtained under the Act. In some cases, CCRA may find it useful to obtain information about a taxpayer from third party sources. By the same token, taxpayers may wish to see what information CCRA has from third parties which may be relevant to the taxpayer’s own affairs. Some of the implications of this are discussed below.
Dealing with CCRA Requirements
Section 231.2 of the Act provides that CCRA can give notice to any person requiring that person to provide information or documentation for any purpose related to the administration or enforcement of the Act. This includes information or documentation obtained from one person about the tax position of another person. Requests for this type of information are often made on an informal basis by CCRA. Sometimes the wording of the request is very broad and open ended. Often, the request relates to the tax position of employees, customers or suppliers. This raises the concern that, while most people feel that it is in their own interest to co-operate with CCRA, they do not wish to be acting against the interests of their employees/customers/suppliers.
Where this is a concern, the best practice is usually to request that CCRA issue a formal requirement for the information or documentation under section 231.2. That way, CCRA is forced to spell out exactly what information is required and, if necessary, they can be asked to clarify the details of the request. In addition, since there is a clear legal requirement to provide the information, the person receiving the requirement can explain to the third party that he or she had no choice but to provide it.
There are only a few limitations to the scope of CCRA’s authority to make these requirements. One is that privileged information does not have to be provided. Another is that there cannot be a "fishing expedition", i.e., CCRA cannot request information about unnamed persons. Where information about unnamed persons is sought, CCRA officials must first obtain a court order to authorize the requirement.
Seeking Third Party Information from CCRA
Where you are in a dispute with CCRA and you know or suspect that CCRA has obtained and is relying upon third party information about your affairs, can you get access to this information? Sometimes, you can get the information from the third party that supplied it, but the third party may refuse to do so for his or her own confidentiality reasons. In many cases, you may not even know who the third parties are.
This issue often arises in transfer pricing cases where the question is often to determine what price or royalty, etc., is charged between independent third parties in the same circumstances as the taxpayer. Since all Canadian taxpayers file Canadian tax returns and most are routinely audited, this information may well be in CCRA’s records. If CCRA does not have the information, it can seek it from the third party using a section 231.2 requirement. The issue is not unique to transfer pricing. It can arise in valuation cases. It can also arise where two or more parties take inconsistent positions as to the tax consequences of a transaction or relationship between them.
Where CCRA uses third party information in reassessing a taxpayer, that information is clearly relevant and should be disclosed to the taxpayer. This creates a conflict, however, because CCRA officials are also bound by the confidentiality provisions of the Act.
According to Information Circular 87R2, CCRA’s policy is that, where third party information forms the basis of a transfer pricing reassessment of a taxpayer, the taxpayer will be so advised. If the taxpayer asks for the information, CCRA will seek the third party’s consent to disclose it, but will not make disclosure without consent. If the taxpayer does not agree with the reassessment and initiates the litigation process by appealing to the Tax Court of Canada, the Act permits the third party information to be disclosed. The Circular states that, at this stage, CCRA’s practice is to give the third party an opportunity to intervene and take steps to protect the confidentiality of the information.
In some cases, CCRA may have information relevant to a taxpayer’s case, but may not use it in reassessing the taxpayer. Sometimes, this is because the CCRA auditor may not even know that this information exists. In other cases, there may be a more conscious decision not to use the information. For example, your tax issue may relate to the deductibility of a royalty paid to a related person. Perhaps you know that there are third party licences of similar property, where CCRA has collected withholding taxes. If CCRA uses that information in a transfer pricing case, it will be covered by IC-87R2 as outlined above. But what if CCRA says that they did not use this information? You may nevertheless want to see it yourself in order to test the validity of CCRA’s position.
This issue arose in Smithkline Beecham Animal Health Inc., where there was a transfer pricing dispute in which the taxpayer requested profitability information from CCRA relating to other Canadian pharmaceutical companies. Even though the matter was in litigation, CCRA refused to provide the information, arguing that it did not form the basis of CCRA’s reassessment. The taxpayer’s motion to compel the information was refused by the Tax Court of Canada. On appeal, the Federal Court of Appeal indicated that the taxpayer might have had a basis for compelling disclosure of the information in order to strengthen its own case or weaken the Crown’s case. However, it was held that the motion was correctly refused on procedural grounds.
The Smithkline case suggests that, in the appropriate circumstances, it may well be possible for taxpayers to obtain third-party taxpayer information from CCRA during the litigation process, even where the information did not form the basis of the reassessment being appealed. Of course, such information may do more harm than good and thus it may not always be in the taxpayer’s interest to seek it.
Protecting Your Information from Disclosure
The foregoing deals with attempts by taxpayers and CCRA to obtain confidential information from third parties. What about protection afforded the third parties who provide information?
As mentioned above, any information provided to CCRA by a taxpayer is protected against disclosure to other taxpayers by the confidentiality provisions under the Act. This protection may be lost, however, once legal proceedings have commenced.
Where there is a concern about the confidentiality of information or documentation provided to CCRA, the best practice is to blank out information that does not relate to the CCRA inquiry and to put a clear notification on the disclosed materials that they are being provided in confidence on the understanding that CCRA will seek the owner’s consent before disclosing them to any third party. This puts you in the best position to be able to control the dissemination of the information by seeking a confidentiality order to limit disclosure.
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.