Canada: Foreign-Based Information

Tax executives and practitioners familiar with administrative procedures under the Canadian Income Tax Act (the "Act") are aware of the broad powers afforded the Canada Customs and Revenue Agency ("CCRA") to conduct audits, to compel the production of books and records and even to obtain and execute search warrants.

A less familiar and, until recently, less commonly used procedure is available to CCRA to require production of "any foreign-based information or document" even where such material is not under the control of the taxpayer. This generally worded and far reaching provision was originally introduced to deal with transfer pricing investigations but is, in fact, much wider in scope and potential application.

Scope and Service of a Requirement to Provide Foreign-Based Information

The rights of CCRA are stated to include the right to require production of "any information or document". While the term "document" is defined to include all communications and financial or other records whether in writing or in any other form, the term "information" is not defined and would likely be even more widely interpreted. Similarly, the extension of the scope of the requirement to any material "available or located outside Canada and that may be relevant to the administration or enforcement" of the Act makes this power one of the potentially most significant in the statute.

A notice requiring the recipient to provide foreign-based information or documents may be served on a Canadian resident person or a non-resident person carrying on business in Canada. The requirement must set out a reasonable time, not less than 90 days, for production of the material requested and must contain a description of the information or document being sought.

Challenging The Requirement

The person on whom a notice is served (but only such person and not anyone else whose affairs may be under investigation or who may be in possession of the documents or information) may refer the notice to a judge for review. Upon the review, the judge may confirm the requirement, vary it as the judge considers appropriate in the circumstances, or set aside the requirement in its entirety if the judge is satisfied that it is unreasonable. There is a significant limitation, however, on the ability of the applicant to argue that a requirement is unreasonable. A requirement will not be considered unreasonable merely because the information or document requested is under the control of or available to a non-resident person that is not controlled by the taxpayer served with the notice if the taxpayer is related to the non-resident. In effect, a Canadian corporation served with a requirement to provide foreign-based information solely under the control of its majority shareholder outside Canada may not have the requirement struck out as unreasonable merely because the shareholder refuses to provide the information.

The issue of what constitutes "control" of conceptual matter such as information or even of documents may itself be difficult to deal with. The person served with the notice will be considered to be related to a non-resident who has the requisite degree of control over the specified information based on the standards that have been developed by common law to determine de jure control. Essentially, control of this nature arises by virtue of ownership of, or the right to acquire, sufficient voting shares to elect a majority of the board of directors and not merely as a result of de facto control such as may exist in the case of a significant but not majority shareholder.

There is no guidance as to the grounds on which a judge may vary or even set aside a notice as being unreasonable. Based on the wording of the Act, a notice should be set aside if it can be demonstrated that the information requested is not relevant to the administration or enforcement of the Act. Similarly, a notice should be considered to be unreasonable if it relates to information or documents exclusively under the control of a person who is not related to the applicant. One would expect that proper grounds on which a notice may be varied would include a demonstration that the time permitted for collection and provision of the information is insufficient or that the information requested is not described with sufficient specificity to permit compliance.

Who Can Authorize The Requirement

The requisite notice is to be served by "the Minister". Whereas previously any power so granted could be delegated only as set out in a regulation to the Act, the authority to exercise powers or perform duties of the Minister under the Act may now be delegated without legislative oversight. A list of delegations signed by the Minister of National Revenue has been released and indicates that the power to serve requirements to provide foreign-based information or documents is delegated to persons holding various headquarters and field positions.

While the entitlement of an appropriately designated CCRA official to authorize a requirement to provide foreign-based information may not be challenged, the issuance of such a notice is an administrative function that is governed by a well established body of law. Generally, an administrative act must be exercised fairly and in good faith, after consideration of all of the circumstances in the case, and with an honest belief that the official is acting in accordance with powers conferred by legislation. The requirement must thus relate to a genuine and serious inquiry as to the tax liability of some specific taxpayer and the person authorizing the notice must have reason to believe that the individuals or corporations under investigation are those referred to in the notice. A mere recital that the information or documents requested may be relevant to the administration or enforcement of the Act is not determinative and may be questioned. It is open to the person upon whom the notice has been served to challenge whether the requirements to act properly have been met and, by compelling the attendance of the individual signing the notice for cross-examination, to challenge its validity.

Sanction For Failing To Comply—Exclusion In Subsequent Litigation

The primary sanction for failure to "comply substantially" with a requirement to produce the specified documents or information is that no item covered by the notice may be introduced thereafter in any civil proceeding relating to the administration or enforcement of the Act, such as an appeal against an income tax assessment, by the recipient of that notice. While this prohibition against introduction of the undisclosed foreign-based information or document in any later tax appeal does not on first reading appear overly burdensome, the practical application of the sanction can be considerably more damaging. If the person served with the notice fails to comply substantially with the notice taken as a whole, no item referred in the notice may be introduced by that person in court. Thus, for example, CCRA may specify ten documents in the notice, of which eight are prejudicial to the taxpayer’s position but two are highly favourable and crucial to the taxpayer’s ability to "make its case" in any subsequent litigation. The requirement for substantial compliance would mean that most if not all of the unfavourable documents would have to be produced or the favourable documents will be excluded from the court proceedings.

This potential prohibition on introduction of evidence that may be critical to the taxpayer’s case argues strongly for an initial application to a judge to challenge the scope, relevance or specificity of the notice. It will be much safer to identify clearly or restrict, to the extent possible, the material required for production at the outset than to argue at a later date that there has been substantial compliance. One strategy that might be adopted in the appropriate case would be, on the reference to the judge, to attempt to split the notice into a series of less comprehensive requirements where the problem described above would not exist.

Further Sanction For Failure to Comply

A further possible sanction for failure to comply with a requirement to produce foreign-based information or documents is contained in the general provisions of the Act relating to offences and punishment. These indicate that every person who has failed to comply with various enumerated requirements, including a requirement to produce foreign-based information or documents, is guilty of an offence and is liable on summary conviction to a fine or both a fine and imprisonment for a term not exceeding twelve months. This would indeed be a drastic sanction in a case involving only a dispute as to the amount of tax owing without any allegation of fraud or misrepresentation, and in circumstances in which the person alleged to have committed the offence is not in a position to effect compliance. This may explain why, to the writer’s knowledge, it has never been pursued by CCRA. Perhaps a further reason for the reluctance of CCRA to attempt to impose sanctions in this manner is a serious doubt as to the validity of the provision. The obligation to produce foreign-based information is absolute and does not on its face provide for any excuse for non-compliance. There are strong arguments under the Charter of Rights and Freedoms, particularly under the clauses dealing with the right to life, liberty and security of the person and the right to be secure against unreasonable search and seizure, that the offences section is unconstitutional. Nevertheless, the mere existence of the potential sanction will be a matter of some concern and cannot be overlooked.

The content of this article is intended to provide a general guide to th esubject matter. Specialist advice should be sought about your specific circumstances.

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