Canada: Background - BP Canada Energy Company v. Canada (National Revenue)

Last Updated: May 3 2017
Article by David Rotfleisch

In a ruling delivered on March 30, 2017, the Federal Court of Appeal allowed BP Canada's tax appeal and dismissed the application brought by the Minister pursuant to ss.231.1(1) Income Tax Act (the "Tax Act"). The original successful application by CRA sought an order from the Federal Court demanding that BP Canada produce their unredacted tax accrual working papers and was granted by the Federal Court Judge.

The Canada Revenue Agency (the "CRA") is granted broad tax audit powers under ss.231.1(1) of the Tax Act Essentially, the CRA can inspect, audit or examine any books or records of a taxpayer and any documents of the taxpayer or any other person that may relate to information that should be in the taxpayer's books and records or relate to any amount payable by the taxpayer under the Tax Act. This can be justified under a self-reporting taxation system such as Canada has; in order for the CRA to ensure that Canadian taxpayers are reporting and paying taxes correctly.

On the other hand, provincial securities legislation requires that public corporations meet various accounting and reporting standards, one of which involves the preparation of tax accrual working papers, also known as uncertain tax positions. Tax accrual working papers lay out a corporation's tax positions as well as the likelihood that each position may be challenged and the likelihood of success in the event that the corporation will succeed on notice of objection or in tax court for each tax position.

The CRA's tax audit powers and the requirement for corporations to keep tax accrual working papers collided and became the key issue in BP Canada Energy Company v Canada (National Revenue) in the Federal Court of Canada and then the Federal Court of Appeal. While the Federal Court had originally ordered BP to turn over their tax accrual working papers, on appeal, the Appellate Court ruled otherwise. That being the case, the Federal Court of Appeal accepted that it was within the Minister's power to demand the tax accrual working papers, but that the demand could not be routine and care and discretion needed to be taken by CRA when asking for these working papers. Call one of our top Toronto tax lawyers to earn more about CRA tax audit powers and how they might apply to you.

Facts – Request for Tax Accrual Working Papers

In the course of the tax audit of BP Canada's 2005 taxation year, the CRA tax auditor found an issue with certain refund interests paid by the Minister to BP Canada but was unable to trace the refunded interest into BP Canada's accounts. It was eventually revealed in the tax audit that the refund interest payment was incorrectly reported in 2007 rather than in the 2005 taxation year. In the course of this tax audit, the CRA tax auditor became interested in several accounting entries in BP Canada's accounts, specifically, the "Interest Expenses Taxes Payable – Disputed Accruals" account. To verify the source of these accounting entries, the CRA tax auditor issued Query 2005-10 requesting the disclosure of the original supporting working papers. These original working papers were BP Canada's tax accrual working papers.

However, BP Canada refused to comply with the request. The reason for the refusal was that the tax accrual working papers would provide the Minister a roadmap to BP Canada's uncertain tax positions as well as the analyses behind those positions. BP Canada later produced a redacted version of the working papers to the CRA tax auditor with BP Canada's uncertain tax positions and the underlying analyses redacted. The redacted version addressed the CRA tax auditor's concern about the accounting entries, but raised another concern. The taxes that were proposed to be assessed were materially lower than the reserves set out in BP Canada's working papers. As a result, the tax auditor demanded the unredacted version of the tax accrual working papers.

After a number of exchanges between BP Canada and the CRA tax auditor, it was eventually determined that contrary to what the numbers in the working papers indicated, the amounts associated with the uncertain tax positions in question were significantly lower than the projected income tax assessment. However, the CRA tax auditor took the position that regardless of what the numbers were, the tax accrual working papers still had to be produced when demanded.

BP Canada on October 15, 2010, confirmed that it would not produce the unredacted version of its tax accrual working papers and in response, the CRA tax auditor announced that a compliance order would be sought. In addition, BP Canada was audited for its 2006 and 2007 taxation years and similar requests for the tax accrual working papers were made. BP Canada again refused to produce the unredacted working papers and instead submitted redacted versions.

On May 8, 2012, the Minister brought an application before the Federal Court seeking an order for the production of BP Canada's working papers. By this time, the Minister had already concluded their audits the 2005 and 2006 taxation years and issued tax reassessments for those years. As such, the stated purpose for obtaining the tax accrual working papers was for the audit of the 2007 and subsequent taxation years. Prior to the Federal Court Judge's decision, the tax audit of BP Canada's 2007 taxation year had concluded with an income tax reassessment, but the Minister had by then issued requests for BP Canada's working papers for the 2008 through 2010 taxation years.

Judicial History - BP Canada Energy Company v. Canada (National Revenue)

In the Federal Court, the judge addressed two main issues: 1) whether the issues lists fell within the scope of ss.231.1(1) of the Tax Act and 2) if so, whether he should exercise his discretion not to compel the disclosure of the information. The Federal Court Judge considered the CRA's internal policy and position on requesting tax accrual working papers, whether the disclosure of the working papers would result in BP Canada self-auditing, whether the working papers fell within the scope of ss.231.1(1), as well as public policy concerns. Furthermore, the Federal Court Judge dismissed BP Canada's Canadian tax lawyer's contention that even if the working papers were compellable, that the Court should decline to exercise its discretion and further rejected any contention that the tax auditor acted in bad faith or that the Minister was unfairly singling out BP Canada. Ultimately, the Federal Court Judge ordered BP Canada to produce the tax accrual working papers as requested by the Minister.

Federal Court of Appeal Decision - BP Canada Energy Company v. Canada (National Revenue)

As a result of the Federal Court's order to produce the tax accrual working papers, BP Canada's Canadian tax litigation lawyers appealed the decision to the Federal Court of Appeal. The Appellate Court considered the scope of ss.231.1(1) and agreed with the Federal Court Judge that the wording of the subsection could not have been drafted in broader terms. The language and context is clear that the Minster must be acting for a purpose relating to the administration or enforcement of the Act in order to make such an order. However, the Minister was clear that the purpose of the order in this case was to gain access to BP Canada's uncertain tax positions, which would be used as a roadmap for tax audits under the Income Tax Act. This, the appeal court found, appeared to be an authorized purpose. Furthermore, it is necessary that the target of the order be documents that relate or may relate to any amount payable by the taxpayer under the Act – this too the Court found was satisfied. The Appellate Court found that the language of the subsection, read on its own, gave the Minister access to any documented information that may help in his tax auditing functions and that the tax accrual working papers can be seen as falling within this description.

However, the Appeals Court found that, while the Minister could compel the tax accrual working papers, they could not do so without restriction. Looking at the context and purpose of the subsection, the Court found that it was clear that Parliament intended that the broad powers of ss.231.1(1) be used with restraint with regards to tax accrual working papers and that the decision of the Federal Court judge must be set aside.

Further, the Appellate Court found that the Federal Court's decision would amount to BP Canada self-auditing. Canadian taxpayers are obligated to self-assess, but generally, taxpayers are not required to tax themselves on amounts that they do not believe to be taxable. Where an issue is reasonably open to debate, the Appellate Court emphasized that taxpayers are entitled to file their tax return on the basis most favourable to them. As such, it is the Minister's role to verify the amounts reported by the taxpayer. In order to do so, the Minister is entitled to be provided with all reasonable assistance in performing CRA tax audits, but CRA cannot compel taxpayers to reveal their so called soft spots. Thus, where BP Canada had no choice but to prepare tax accrual working papers documenting its uncertain tax positions, being forced to produce those working papers from 2005 onwards clearly constitute a requirement for BP Canada to self-audit.

The Appellate Court also considered the purpose of the tax accrual working papers and their necessity. It was noted that in Canada, tax accrual working papers are created by or for independent financial auditors in order to assist in the process leading to the certification of a corporation's financial statements in accordance with Generally Accepted Accounting Principles. Furthermore, the Court recognized that provincial securities legislation in Canada required that financial statements be certified by independent auditors and that tax accrual working papers are necessary for those auditors to assure that the financial statements fairly and accurately reflect the true financial situation of the corporation under audit. The intervener, CPA Canada, raised the argument that general and unrestricted access to tax accrual working papers would undermine the obligation on publicly-traded corporations to meet their financial reporting obligations under provincial securities legislation. The concern is that publicly-traded corporations would tend to refrain from documenting issues and be less candid about their tax risks to their external auditors. This would be directly detrimental to Canadians as it would necessarily result in less protection to investors due to the decreased reliability of financial statements. The Appellate Court agreed with the intervenor that ss.231.1(1) has to be interpreted in context, including the relevant provincial laws. The Court of Appeal referenced the Supreme Court of Canada's decision in Giffen (Re) where it was found that even though bankruptcy was clearly a federal matter, it was dependent on provincial property and civil rights legislation and that s.72(1) of the Bankruptcy and Insolvency Act contemplates interaction with provincial legislation. Similarly, the Appellate Court was of the opinion that the power created under federal legislation was not intended to ride roughshod over provincial laws and that the intention was for the federal and provincial laws to be interpreted harmoniously. As such, the Federal Court of Appeal concluded that the Minster could not use ss.231.1(1) for the purpose of obtaining general and unrestricted access to the portions of BP Canada's tax accrual working papers which reveal its uncertain tax positions. To learn more about the CRA tax auditors powers to compel tax information and how this decision on uncertain tax positions and tax accrual working papers can affect your business, call our experienced Toronto tax law firm and speak to one of our expert Canadian tax lawyers.

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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