Overview – What is the Test for Tax Evasion?
In R v Patry 2018 BCSC 1524 the Supreme Court of British Columbia (the "Court") found that Mr. Patry did not have the requisite culpable state of mind for a tax evasion conviction. The reasoning provided by the Court reaffirms that under paragraph 239(1)(d) of the Income Tax Act, the requisite threshold for a finding of mens rea for a tax evasion offence is relatively high. The court's reasoning also reaffirms that the proper test for the mens rea analysis is a knowledge-based approach.
Whether a taxpayer is guilty of tax evasion, or has simply failed to apply the relevant tax laws, often turns on the state of the mind or the mens rea of the accused at the relevant time. There has been much debate as to what the proper test for mens rea should be in the context of tax evasion offence. At the time of writing, this issue has not been litigated at the Supreme Court level, and the question as to the proper test has been debated at the appellate level.
Generally, the courts have applied two approaches. In earlier cases, a taxpayer's intention to deceive was a required element of the crime of tax evasion. In other words, deception was a required element of a guilty mind under paragraph 239(1)(a). Prior to R v Patry, the most recent case law rejected deception as a required element of a tax evasion offence. Instead, the courts adopted a knowledge-based approach when assessing the state of mind of a taxpayer who had been accused of tax evasion.
In its ruling, the Court states that a taxpayer cannot be convicted on tax evasion "for being wrong, only for knowingly being wrong."
R v Patry lends further support to the conclusion that a court is more likely to assess the knowledge of the taxpayer at the relevant time in determining whether the taxpayer is guilty of the crime of tax evasion.
Facts – R v Patry
Raymond Patry was a full-time auditor at the Canada Revenue Agency (the "CRA") from 1991-2005. In 2005, on the recommendation of his physician following a closed head injury, Mr. Patry requested unpaid leave from the CRA. During his testimony, Mr. Patry stated that he felt compelled to request an unpaid leave because CRA was "targeting" him in order to find a reason to terminate his employment. Ultimately, in February 2008, Mr. Patry resigned from the CRA.
In 2005, while on unpaid leave, Mr. Patry started a business under the operating name, "Accounting Professionals." He then registered a business number for his new operation.
Sometime in 2008, approximately three years after obtaining a business number, Mr. Patry opened a GST account. He subsequently filed monthly GST returns under the operating name, Accounting Professionals for the period starting in March 2008 and ending in December 2010. Mr. Patry took the position that he had no obligation to file GST returns for the years prior to this period because Accounting Professionals had sufficient Income Tax Credits ("ITC") to offset the GST that Accounting Professionals had collected prior to March 2008.
During the trial, there was a question as to whether Accounting Professionals operated as a partnership between Mr. Patry and Mrs. Patry, or whether the business was operated solely by Mr. Patry. The Court ultimately determined that Ms. Patry was not a partner in Accounting Professionals.
Accounting Professionals was a tax preparation service whose primary purpose was to implement for its clients Mr. Patry's "tax compliance strategy".
Tax Compliance Strategy of Accounting Professionals : Tax Evasion or Tax Planning?
During the course of the trial, Mr. Patry testified of his firm belief that his "tax compliance strategy" was sound, and fully compliant with the CRA's interpretation of the relevant provisions of the Income Tax Act. Mr. Patry cited several CRA Interpretation Bulletins, Income Tax Folios, and Information Sheets that he had relied on while designing his tax-planning scheme.
He testified that the cited CRA publications supported the conclusion that a taxpayer can retroactively change the purpose of a transaction, thereby taking advantage of the relevant deemed disposition rules. He further testified that the same CRA publications supported the conclusion that a single transaction can be re-characterized as "an adventure or concern in nature of a trade." He therefore concluded that it was a sound strategy for Accounting Professionals to retroactively change the use of a taxpayer's real property from principle residence to a business inventory, triggering the deemed disposition rules.
Additionally, Mr. Patry testified that this single transaction met the definition of "adventure or concern in nature of a trade" under s. 248(1) of the Income Tax Act. Based on this line of reasoning, the taxpayer would then be entitled to claim business expenses and losses in relation to this single transaction. Additionally, Mr. Patry was of the belief that the business losses resulting from this single transaction could then be carried forward without first being applied to the business income in the year the losses were incurred.
From 2005 to 2008, Mr. Patry, acting on behalf of his clients, filed their income tax returns and applied the Accounting Professionals' "tax compliance strategy". All the clients had bought and sold real property at some point in the past. The clients who testified varied in their degree of recollection of the details of the Accounting Professionals' "tax compliance strategy." Many had simply provided Mr. Patry with requisite documentation and knew little else. Some of Accounting Professionals' clients testified that Mr. Patry had assured them that his tax strategy was sound, and complied with Canadian taxation law.
Mr. Patry filed income tax returns using "net file", and he did not fill out the "professional tax preparer" box on the income tax returns he prepared for his clients. In cross-examination, Mr. Patry made a distinction between a tax professional and a tax representative. He took the position that he was a tax representative, and therefore he was not required to check the box. Additionally, Mr. Patry stated that even though he did not fill out the "professional box preparer", the CRA would have had access to the same information regardless of whether or not he filled out the "professional tax preparer" box.
When filing his clients' business expenses and losses resulting from the Accounting Professionals' "tax compliance strategy," Mr. Patry entered a business name in his clients' income tax returns. Mr. Patry testified that using a business name when filing his clients' tax returns was not for the fraudulent purpose of hiding his clients' true identity. He stated that the function of the Quick Tax computer program required a business name to be filled in and that the returns could not be filed without Mr. Patry having done so. The business names were the last names of the clients or their initials, followed by the words "Properties", "Enterprises" or "Investments".
Acting on behalf of Accounting Professionals, Mr. Patry identified himself as "Drew Richards" or "Mr. Richards" when communicating with the CRA. Mr. Patry testified that "Drew Richards" was his birth name, and he did not use the name for any fraudulent purposes. He once again testified to his suspicions of being targeted by the CRA, explaining that he used his birth name not to conceal his identity, but to ensure that the CRA's bias against him personally did not impact the agency's assessment of his clients.
Issues – R v Patry
During the trial, the Crown raised several issues:
- Did Mr. Patry willfully evade or attempt to evade income taxes between December 31, 2005 and August 21, 2008 by failing to report taxable income contrary to s. 219(1)(d) of the Income Tax Act?
- Did Mrs. Patry willfully evade or attempt to evade incomes taxes between December 31, 2005 and August 21, 2008 by failing to report taxable income?
- Did Mrs. Patry obtain or claim refunds or credits under the Income Tax Act which she was not entitled to by making, participating in, assenting or acquiescing in the making of false or deceptive statements insofar as she failed to report the entirety of her taxable income?
- Did Mr. Patry and Mrs. Patry wilfully evade or attempt to evade remittance of GST contrary to s. 327(1)(c) of the Excise Tax Act from December 31, 2005 to April 1, 2008 taxation period?
- Did Mr. Patry and Mrs. Patry wilfully evade or attempt to evade payment of income taxes by claiming false business losses on the income tax returns of 32 other taxpayers, contrary to s. 239(1) of the Income Tax Act?
- Did Mr. Patry and Mrs. Patry obtain or claim refunds or credits under the Income Tax Act to which their clients were not entitled by making, participating in, or assenting to or acquiescing in the making of false business losses on the income tax returns of 18 other taxpayers, contrary to s. 239(1)(d) of the Income Tax Act?
This article focuses on the Court's interpretation of s. 239(1)(d) of the Income Tax Act, and the application of this provision to the facts of this case. As such, only the fifth and sixth issues are examined, and the scope is limited to the application of this provision to the conduct of Mr. Patry.
Canadian Tax Lawyer Analysis of R v Patry: Crime of Tax Evasion – A relatively high threshold for a finding of a guilty mind
In Canada, tax evasion is a criminal offence that upon conviction can result in a prison sentence of up to five years. The standard of proof on a tax evasion conviction is "beyond a reasonable doubt", the same standard as any other crime which carries a prison sentence. The Crown has the burden to prove that the taxpayer is culpable in his conduct and intention.
The elements of the offence are laid out in paragraph 239(1)(d) of the Income Tax Act, which states that the crime of tax evasion is committed when,
"[The taxpayer] wilfully, in any manner, evaded or attempted to evade compliance with this Act or payment of taxes imposed by this Act
The correct interpretation of this provision has been litigated heavily over the years. There has been much ambiguity as to the scope of the requisite mens rea: what is the required threshold of guilty mind for a tax evasion conviction? Specifically, when has a taxpayer "wilfully" evaded or attempted to evade taxes?
A literal reading of paragraph 239(1)(d) suggests a broad definition of the offence of tax evasion. As clarified in R v Klundart (2004), 187 C.C.C. (3d) 417 [Klundert], this provision is all encompassing, bringing within its scope "any manner" of conduct which has the effect of evading or attempting to evade taxes.
However, despite its broad wording, the courts have consistently construed the provision narrowly by giving a very restrictive definition to the term "wilfully." The settled law is that the requisite threshold for the mens rea element of tax evasion offence is relatively high. However, there has been an ongoing debate as to the proper test that the courts should apply when assessing the state of mind of a taxpayer who has been accused of tax evasion.
The crux of the debate is whether a finding of deceptive conduct by the taxpayer is required in finding a taxpayer guilty of tax evasion offence. Earlier cases consistently affirm that a finding of deceit is a necessary element of tax evasion. However, more recent cases reject this view.
In R v Keegstra  3 S.C.R. 697, the Supreme Court states that the term wilfully refers to a culpable state of mind, and the exact meaning of the word depends on the context in which it is used. In R v Paveley 70 DLR (3rd) 237 [Paveley], the Saskatchewan Court of Appeal defines the term willfully in the context of tax evasion offence. Specifically, in Paveley the court defines the term willfully to mean that the taxpayer's conduct was carried out with the "particular purpose" or "ulterior motive" of evading the payment of tax. In other words, a taxpayer is guilty of the offence of tax evasion when, at the relevant time, he has the "specific intent" of evading or attempting to evade payment of tax under the Income Tax Act.
Courts have consistently acknowledged that whether a taxpayer's conduct point to his "specific intent" to evade or attempt to evade taxes must be considered with certain characteristics of the Income Tax Act in mind. This piece of legislation is notoriously complex, subject to ongoing revisions and may be interpreted incorrectly even by intelligent well-informed citizens. For this reason, the court in Klundart states that a "finding of mistake or ignorance as to one's liability to pay tax under the Income Tax Act may negate" the presence of the "specific intent" to evade taxes.
In Klundart, the Ontario Court of Appeal states that a knowledge-based analysis is the correct approach is assessing the culpability of a taxpayer for the crime of tax evasion.
Specifically, the question to be asked is not whether a taxpayer had engaged in deceitful conduct. Rather, the question is whether the taxpayer had knowledge of his duties and obligation under the relevant provisions of the Income Tax Act, and whether, knowing his obligations, the taxpayer then knowingly failed to follow the law.
Defence of Tax Evasion – Mistaken Belief
A number defences are available to a taxpayer who is facing a charge of tax evasion. Mistaken belief is one of the more important and readily acceptable defenses. This defence can constitute a taxpayer's mistake in his understanding of the law, in the facts of his case, or a combination of both.
A taxpayer can demonstrate a mistake in law by presenting evidence that supports the taxpayer's claim that he did not have knowledge, nor was he wilfully blind to the correct interpretation of the specific provisions of the Income Tax Act that are relevant to his particular factual scenario.
Tax Evasion as defined in R v Patry
In R v Patry, the Court defines the actus reas of the crime of tax evasion broadly, stating that "actus reas of tax evasion offences is an act or course of conduct which has the effect of evading or attempting to evade" a taxpayer's obligation under the Income Tax Act. This definition is in line with past precedent.
Similar to earlier cases, the Court also highlights the critical role of mens rea analysis in restricting the application of the crime of tax evasion. Citing Klundart, the Court reiterates that it is a taxpayer's culpable state of mind that distinguishes a legitimate tax planning scheme from a dishonest tax evasion strategy. Only a dishonest tax evader is guilty of the crime of tax evasion under the Income Tax Act.
Once again, in citing the law on mens rea analysis for a tax evasion offence, the Court reiterates the precedent, stating that a knowledge-based analysis is the correct approach. The Court goes on to state that there are two elements in the mens rea of tax evasion: (1) knowledge of duty to pay certain taxes, and (2) an intention to not pay those taxes.
A knowledge-based approach is in line with the purpose of the Income Tax Act, and its underlying public policy. The crime of tax evasion as defined by paragraph 239(1)(a) is a residual and general crime, found in Part IV of the Income Tax Act under the heading of "Administration and Enforcement". The general purpose of this section is to create consequences for taxpayers who fail to fulfil their obligations and duties under this legislation. The underlying public policy is that when revenue is diverted from the tax authorities because of a taxpayer's failure to fulfil his duties, the taxpayer must face consequences. As such, the more reasonable approach in analyzing the mens rea of tax evasion is to assess whether, at the relevant time, the taxpayer had knowledge of his obligation and duties under the Income Tax Act, and knowingly intended not to fulfill these obligations.
The case of R v Patry lends support to the position that moving forward, a court is more likely to apply a knowledge-based analysis when a taxpayer is accused of tax evasion. It is less likely for a court to focus on and analyze facts that go to the issue of deceit.
Tax Tips & Tax Evasion – Lessons from R v Patry
Reducing Taxing or Deferral Strategies
The law is clear: it is perfectly legal for taxpayers to arrange their affairs so as to minimize their tax burden. Although complex, the Income Tax Act offers many opportunities for taxpayers to reduce, or at the very least defer their taxes.
Whether taking advantage of various corporate reorganization techniques or estate planning strategies, tax planning can be instrumental in changing the lives of business owners and their families. However, as the case of Mr. Patry suggests, seeking competent, professional tax advice is critical in ensuring that you are complying with the Income Tax Act while taking advantage of the tax planning strategies that it offers.
Contact one of our experienced and expert Canadian Tax Lawyers to take advantage of the many legitimate tax planning opportunities that are available.
Tax Evasion & Aggressive Tax Planning
As the case of Mr. Patry suggests, a taxpayer engaged in tax planning can easily be accused of committing the crime of tax evasion. Proper representation is key in the outcome of a taxpayer's case. Contact one of our Canadian Tax and Trial Lawyers for experienced and time tested representation if you are facing a charge of tax evasion or the CRA has referred your file to the Aggressive Tax Planning division of the CRA.