Introduction: CRA has the power to compel disclosure of confidential reports
In Canada (National Revenue) v Atlas Tube Canada ULC, the Federal Court held that Canada Revenue Agency (CRA) could compel a private corporation to disclose its draft tax due diligence report during the course of an ongoing audit. This case underlines the importance of ensuring that tax planning or due diligence documentation is protected by solicitor client privilege from a Canadian tax lawyer.
A due diligence process was conducted to prepare for the transactions.
Atlas Tube Canada ULC (Atlas), a private Alberta company, was a subsidiary of a US company called JMC Steel Group Inc. (JMC). On March 30, 2012, JMC acquired shares of an Ontario public corporation, Lakeside Steels Inc (LSI) by way of a plan of arrangement. To prepare for this transaction, the general counsel of JMC engaged Ernst & Young LLP to conduct Canadian tax due diligence. After the transaction was completed, CRA began its audit of Atlas for its taxation year ended in April 2012 and requested a copy of the draft due diligence report. Atlas refused to provide the copy.
The Minister met the low threshold to establish relevancy of the report
Under s.231.1 of the Income Tax Act, an authorized person may inspect, audit or examine the books and records of a taxpayer that may relate to the administration or enforcement of the Act. Both the CRA and Atlas agreed it's a low threshold for the CRA to establish the report may only be relevant, but they disagreed on whether the CRA actually met the threshold. Citing previous jurisprudence, the Federal Court adopted the position that the CRA only needs to meet a low threshold and ruled that the CRA had met that burden as there was a possibility that the valuation of the Canadian side of the acquisition would impact the US share that was under CRA's review.
Atlas was not able to establish solicitor-client privilege
Atlas also argued the report should be protected by solicitor-client privilege. By analyzing the evidence, the Court found that the decision to hire EY Canada to conduct the tax due diligence and the subsequent generation of the report served two business decisions: 1. Whether to proceed with the transaction and at what price; 2. How to structure the transaction. Based on the fact that Canadian tax due diligence was among several categories of due diligence that JMC was undertaking with the assistance of third parties and there was no evidence that indicated there had been a change of the purpose of the results from the decision to proceed with the transaction to obtain legal advice on the structure of the transaction, the Court concluded the dominant purpose of the report was to inform JMC's business decision. Therefore, the Court held that solicitor-client privilege did not apply to the report.
Federal Court took a narrow view of the decision in BP Canada Energy Co.
Finally, Atlas relied on the principle that a taxpayer is not compelled to self-audit which was established in BP Canada Energy Company v Minister of National Revenue (2017 FCA 61). The Court in BP Canada ruled that CRAwas not entitled to receive internal tax accrual working papers (TAWPs) from taxpayer since such documents were intended to access the uncertain tax position taken by public companies in filing their tax returns. Although the Federal Court in the case at hand recognized the decision in BP Canada is to be read as precluding general and unrestricted access to TAWPs on a prospective basis, outside of the context of an audit of particular issues, the Court decided to take a narrower view of the decision in BP Canada on the basis that the request for the report was made in the context of an active audit. Therefore, compelling the copy of the draft report would not offend the decision of BP Canada.
Tax Tip – The Importance of solicitor client privilege
While the taxpayer was unsuccessful, this case again demonstrates why Canadian tax lawyers should be retained before dealing with accountants. The CRA may be entitled to access communications between a taxpayer and non-lawyers, but legal advice is still protected under solicitor-client privilege.