Canada: Audit And Investigations—Limits From The Supreme Court Of Canada

In 2002, two important decisions were released by the Supreme Court of Canada which affect tax audits. In both cases, the Supreme Court provided additional protections to taxpayers whose affairs may come under investigation by the Canada Customs & Revenue Agency (the "CCRA").

R. V. Jarvis: When Does an Audit become an Investigation?

In the 2002 case of R. v. Jarvis, the Supreme Court held that compliance audits by the CCRA must be treated differently from investigations into potential offences, such as tax evasion. The Court stated:

While taxpayers are statutorily bound to co-operate with CCRA auditors for tax assessment purposes (which may result in the application of regulatory penalties), there is an adversarial relationship that crystallizes between the taxpayer and the tax officials when the predominant purpose of an official's inquiry is the determination of penal liability. When officials exercise this authority, constitutional protections against self-incrimination prohibit CCRA officials who are investigating ITA [a reference to the Canadian Income Tax Act] offences from having recourse to the powerful inspection and requirement tools in ss. 231.1(1) and 232.2(1) [references to CCRA's basic statutory power to audit the books and records of a taxpayer and to formally require a taxpayer to produce information or documents]. Rather, CCRA officials who exercise the authority to conduct such investigations must seek search warrants in furtherance of their investigation.

In Jarvis, a tip was given to CCRA that the appellant had failed to report income. Internal CCRA policy required that such matters be referred to the branch of the CCRA known as the Special Investigation Section which is responsible for investigating penal or criminal offences under the Act. Contrary to this policy, the CCRA auditor conducted the matter as a typical compliance audit, including interviewing Mr. Jarvis without cautioning him as to his rights or the fact that he could be facing criminal charges. As a result, much evidence was obtained by the auditor before the matter was eventually transferred by her to Special Investigations.

Although on the facts of Jarvis, the Court did not find that the auditor had improperly used her audit powers to obtain information for an investigation into criminal wrongdoing, the Court stated that "where the predominant purpose of a particular inquiry is the determination of penal liability, CCRA officials must relinquish the authority to use the inspection and requirement powers under ss. 231.1(1) and 231.2(1)." Once the predominant purpose becomes an investigation into criminal liability, rather than a routine compliance audit, the taxpayer's rights under the Canadian Charter of Rights and Freedoms (such as the right against self-incrimination and the right to be protected from unreasonable search and seizure) are engaged. The Court, however, went on to recognize that a degree of latitude in tax investigations must be granted, noting, for example, that "mere suspicion that an offence has occurred" does not transform an audit into an investigation, nor is a decision to refer the matter to Special Investigations determinative. Each case will turn on its facts, and the Court listed several factors which should be considered:

One. Did the authorities have reasonable grounds to lay charges? Does it appear from the record that a decision to proceed with a criminal investigation could have been made?

Two. Was the general conduct of the authorities such that it was consistent with the pursuit of a criminal investigation?

Three. Had the auditor transferred his or her files and materials to the investigators?

Four. Was the conduct of the auditor such that he or she was effectively acting as an agent for the investigators?

Five. Does it appear that the investigators intended to use the auditor as their agent in the collection of evidence?

Six. Is the evidence sought relevant to taxpayer liability generally? Or, as is the case with evidence as to the taxpayer's mens rea, is the evidence relevant only to the taxpayer's penal liability?

Seven. Are there any other circumstances or factors that can lead the trial judge to the conclusion that the compliance audit had in reality become a criminal investigation?

In the end, Jarvis does little to clarify precisely when an audit becomes an investigation. However, the discussion of the distinction makes clear the importance of ascertaining from an auditor the assurance, verbally or in writing, that he or she is not conducting a criminal investigation or, alternatively, confirming that any information or documents sought are for the purposes of conducting a compliance audit and not for purposes of a criminal investigation. If there is any question about the intentions of the auditor, then the taxpayer may wish to insist on exercising his or her rights not to be questioned or to be inspected other than by way of a search warrant or other compulsory power until the auditor makes his or her position clear.

Protecting Privileged Documents

Tax investigations often involve CCRA officers seeking documents from the taxpayer's lawyer, either by way of a search warrant or a requirement to produce documents issued under the Income Tax Act. When CCRA resorts to seeking information or documents from the lawyer by means of a Search Warrant, it must respect solicitor-client privilege and follow a procedure set out in the Act or a virtually identical procedure in the Criminal Code (the Code). The statutory procedures require the sealing of the records and delivering them to a judge for a determination as to whether the documents are privileged.

In another 2002 decision, R. v. Lavallee, the Supreme Court held that the statutory procedures in the Code to be followed, in a case involving the execution of a search warrant on a lawyer, inadequately protected the fundamental value of solicitor-client privilege.

The Court's decision is a ringing endorsement of the principles of solicitor-client privilege, and the need to protect it and make it "as close to absolute as possible to ensure public confidence."

The Court found that the statutory scheme for sealing up records, delivering them to court and bringing an application within a short time period (14 days) inadequately protected privilege because non-compliance with these requirements, even inadvertent non-compliance, could result in the privilege being lost. As a result, the Court struck down the statutory procedures and set out 10 requirements which now must be met if documents are to be required from counsel. The 10 requirements are:

One. No search warrant can be issued with regards to the documents that are known to be protected by solicitor-client privilege.

Two. Before searching a law office, the investigative authorities must satisfy the issuing justice that there exists no other reasonable alternative to the search.

Three. When allowing a law office to be searched, the issuing justice must be rigorously demanding so to afford maximum protection of solicitor-client confidentiality.

Four. Except when the warrant specifically authorizes the immediate examination, copying and seizure of an identified document, all documents in possession of a lawyer must be sealed before being examined or removed from the lawyer's possession.

Five. Every effort must be made to contact the lawyer and the client at the time of the execution of the search warrant. Where the lawyer or the client cannot be contacted, a representative of the Bar should be allowed to oversee the sealing and seizure of documents.

Six. The investigative officer executing the warrant should report to the Justice of the Peace the efforts made to contact all potential privilege holders, who should then be given a reasonable opportunity to assert a claim of privilege and, if that claim is contested, to have the issue judicially decided.

Seven. If notification of potential privilege holders is not possible, the lawyer who had custody of the documents seized, or another lawyer appointed either by the Law Society or by the court, should examine the documents to determine if a claim of privilege should be asserted, and should be given a reasonable opportunity to do so.

Eight. The Attorney General may make submissions on the issue of privilege, but should not be permitted to inspect the documents beforehand. The prosecuting authority can only inspect the documents if and when it is determined by a judge that the documents are not privileged.

Nine. Where the sealed documents are found not to be privileged, they may be used in the normal course of the investigation.

Ten. Where the documents are found to be privileged, they are to be returned immediately to the holder of the privilege, or to a person designated by the court.

The impact of the Court's decision in Lavallee is still uncertain. The statutory procedure that was struck down was the search warrant provision in the Code in the context of a law office search warrant, although a virtually identical provision in the Act must now also be considered unconstitutional. However, CCRA still has powers to require documents to be produced under audit provisions (which do not require approval by a judge), and has general search warrant powers under the Code. In the absence of a new statutory procedure, judges will follow the guidelines set out above to ensure that privilege is sufficiently protected.

The more interesting question is whether requirements to produce documents served on lawyers can be valid in the absence of a judge's order. As the third criterion notes, the Supreme Court is concerned that a Justice "rigorously" review any such search to ensure maximum protection of solicitor-client confidentiality. It may be difficult for CCRA to justify requiring documents to be produced from law firms without having sought approval from a judge.

We wish to acknowledge the contribution of Paul Schabas to this publication.

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.

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