Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax, July 2008
Under the exchange of information provisions of Canada's tax treaties, the Canada Revenue Agency (CRA) is able to request taxpayer information from its treaty partners. In 2002, the Auditor General of Canada found that those exchange of information provisions "have not been used frequently." In 2006, the Commissioner of the Internal Revenue Service (IRS) observed that an exchange of information had been critical to an investigation in which the IRS and the CRA jointly "announced significant progress in unravelling an abusive cross-border tax scheme." When she delivered last year's long-awaited follow-up to her 2002 report, the Auditor General of Canada noted several important changes within the CRA, including the combination of International Audit and Large Business Audit to form the new International and Large Business Directorate, which included the Competent Authorities Services Division – a division responsible, among other things, for international exchange of taxpayer information. In addition, the Auditor General remarked that aggressive tax planning, which includes international tax compliance, has been one of the CRA's top four compliance priorities since 2004.
Against this background of increasing cross-border tax enforcement activity, Fifth Protocol (the Protocol) to the Canada-United Sates Income Tax Convention (the Treaty) will amend Article XXVII, the exchange of information provision in the Treaty, to allow the CRA and the IRS to obtain information that "may be relevant" (not only information that "is relevant," as reflected in the current version of the Treaty) in carrying out their domestic laws concerning taxes to which the Treaty applies to the extent the taxation under those laws is not contrary to the Treaty. This is the single most important change in the Protocol relating to the exchange of information between the tax authorities of the U.S. and Canada. The Technical Explanation (TE) to the Protocol reviews the reasoning behind this change in some detail:
New paragraph 1 [of Article XXVII] changes the phrase "is relevant" to "may be relevant" to clarify that the language incorporates the standard in Code section 7602 which authorizes the Internal Revenue Service to examine "any books, papers, records, or other data which may be relevant or material." (Emphasis added.) In United States v. Arthur Young & Co., 465 U.S. 805, 814 (1984), the Supreme Court stated that "the language 'may be' reflects Congress's express intention to allow the Internal Revenue Service to obtain 'items of even potential relevance to an ongoing investigation, without reference to its admissibility.'" (Emphasis in original.)
The CRA and the IRS are likely to use Article XXVII more frequently as a result of this more relaxed threshold test. At the same time, however, the TE promises that overly broad fishing expeditions will not be permitted. Examples offered in the TE of impermissible information requests are those:
(a) seeking information about all bank accounts maintained by residents of one state in the other state; or
(b) seeking information about bank accounts maintained by the residents of one state at a particular bank in the other state.
The Protocol provides that if specifically requested by the requesting country, the country from which the taxpayer information is requested must provide that information in the form of depositions of witnesses and authenticated copies of unedited original documents, including books, papers, statements, records, accounts and writings. The intent of this provision, according to the TE, is to ensure that the taxpayer information may be introduced as evidence in the judicial proceedings of the requesting country.
Requested information must be produced even where:
(a) the information is held by a financial institution, nominee or person acting in an agency or fiduciary capacity;
(b) the information relates to a person who is neither a resident of Canada or the U.S.;
(c) there is no information in the tax administration's files (the country from which the information is requested would then be obliged to seek out the information requested using its own information gathering measures);
(d) the country from which the information is requested has no interest in the information; or
(e) the limitation period has expired in the country from which the information is requested.
In the last situation, the TE notes that in "many cases, relevant information will still exist in the business records of the taxpayer or a third party, even though it is no longer required to be kept for domestic purposes." That observation alone should serve as a timely reminder to all taxpayers doing business in Canada and the U.S. to review their information retention policies without delay.
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