Emily Gair, Vancouver, and David Robertson, Toronto
Under the Income Tax Act (the Act), the Minister of National Revenue is granted broad powers to request books, records and documents for the purpose of the enforcement and administration of the Act. These powers are not without limits, however. The Minister is precluded from obtaining disclosure of information or documents in certain circumstances, including where the information or document is protected by solicitor-client privilege.
This recent Federal Court of Canada case involved an application made by the Minister pursuant to section 231.7 for an order requiring the respondent, Investmentco, to comply with the Minister’s request for information made pursuant to section 231.1 of the Act. More specifically, the Minister requested that the respondent provide a copy of a spreadsheet referred to as the master summary pricing model (MSPM) in its unredacted form.
The respondent had redacted portions of the MSPM on the basis that the information contained in redacted cells was protected by solicitor-client privilege. The respondent also argued, in the alternative, that the production of the redacted portion of the MSPM should not be ordered because:
- The Minister was out of time to seek its production because the relevant audit had concluded
- The MSPM constituted tax accrual working papers (TAWPs) and therefore should not be ordered to be produced
- The production of the MSPM would undermine the discovery process in related proceedings in the Tax Court of Canada
Relevant statutory provisions and jurisprudence
Subsection 231.1(1) of the Act grants the Minister the authority to request and examine taxpayers’ records. Section 231.2 is a related provision whereby the Minister may issue a formal requirement to provide documents or information. Where the Minister is of the view that the taxpayer has not complied with her request for information under section 231.1 or requirement for information under section 231.2, the Minister may make an application to the Court for a compliance order pursuant to section 231.7.
Under section 231.7, a judge may order the taxpayer to provide any information or document the Minister is seeking under section 231.1 or 231.2 if the conditions necessary for the issuance of a compliance order are met. One of the conditions is that the information or document is not protected from disclosure by solicitor-client privilege.
Solicitor-client privilege is defined in subsection 232(1) of the Act which reads, in part, “the right... to refuse to disclose an oral or documentary communication on the ground that the communication is one passing between the person and the person’s lawyer in professional confidence.”
In addition to the traditional protection afforded to communication between solicitor and client, the courts have placed additional limits on the Minister’s broad powers to request documents. In particular, the Federal Court of Appeal in BP Canada Energy Company v Canada (National Revenue), 2017 FCA 61 upheld the “unwritten rule” that the Minister cannot routinely request TAWPs. In BP, the Federal Court of Appeal described TAWPs, noting that “their purpose is to identify uncertain tax positions and provide for reserves which will allow the independent auditors to certify that the financial statements fairly and accurately reflect the financial situation of the corporation under audit.” It is easily appreciated that the regular disclosure of TAWPs would provide the Minister with a “road map” for potential audit issues.
Background
The Canada Revenue Agency conducts annual audits of Investmentco, which is a full-service investment firm and is an indirect, wholly owned subsidiary of a bank. As part of its 2016 audit of NBI, the CRA issued a request for information pursuant to section 231.1 of the Act in relation to certain books, records and documents in connection with suspected dividend rental arrangement transactions.
In response to the query, the respondent claimed solicitor-client privilege on parts of the documents requested, including the MSPM dated July 18, 2016. The respondent provided the redacted MSPM to the Minister and advised that the redacted column, which sets out certain calculations, reflected legal advice provided to NBI in two legal opinions from 2012 and 2013. More specifically, evidence was given that the MSPM computes reserves, if any, in respect of certain share repurchase transactions in a manner consistent with that legal advice and forms part of the related group’s tax accrual working papers.
On May 28, 2021, after obtaining what she viewed as unsatisfactory responses to requests for further particulars of the solicitor‐client privilege claim, the Minister brought a summary application to seek the unredacted copy of the MSPM pursuant to section 231.7.
On June 18, 2021, less than one month later and before the Minister’s summary application was even scheduled for hearing by the Federal Court, the Minister reassessed Investmentco in relation to the share repurchase transactions that the Minister alleges are part of a dividend rental agreement for Investmentco’s 2016 taxation year.
On September 16, 2021, Investmentco objected to the Minister’s reassessment of its 2016 taxation year. The correct taxation of the share repurchase transactions was also at issue in the Minister’s reassessment of Investmentco and its indirect parent’s 2012 taxation years; reassessments of its 2012 taxation years have been appealed to the Tax Court of Canada.
Federal Court Decision
Solicitor-client privilege does not apply to the redacted information
In her decision, Justice Kane of the Federal Court concluded that the MSPM is not protected by solicitor-client privilege. Drawing on the Federal Court of Appeal’s reasoning in Canada (Public Safety and Emergency Preparedness) v Canada (Information Commissioner, 2013 FCA 104, Justice Kane explained that there is a continuum of solicitor-client-privileged communications and that not all end products of legal advice falls on that continuum. In particular, Justice Kane stated that an end product of legal advice will be privileged only to the extent that it “communicates the very legal advice given by counsel.”
Considering the MSPM specifically, Justice Kane emphasized that the MSPM “is a set of computations with some associated text” which “reflects the operational implementation, outcome or end product of legal advice provided.” Though the MSPM reflects the operational implantation or end product of legal advice, Justice Kane concluded that production of the unredacted MSPM would not disclose the legal advice provided to Investmentco. For this reason, Justice Kane was not satisfied that the MSPM was protected by solicitor-client privilege.
The Court should review the underlying legal opinions to determine if the MSPM constitutes communications protected by solicitor-client privilege
In coming to her decision, Justice Kane reviewed the two 2012 and 2013 legal opinions in their unredacted form, which were kept under seal.
Justice Kane acknowledged that a court should exercise its discretion to review solicitor-client communications “sparingly” and only where the necessity to do so is established. In these circumstances, Justice Kane determined it was necessary to review the 2012 and 2013 legal opinions, as it was not possible to determine whether the redacted MSPM reflected the legal advice provided based only on the review of the MSPM.
The MSPM should be ordered to be produced
The respondent advanced three alternative arguments for the non-disclosure of the MSPM. Having considered these alternative arguments, Justice Kane determined that there was no impediment to issuing the order under section 231.7 of the Act for the production of the MSPM as requested pursuant to section 231.1 of the Act.
The audit for Investmentco’s 2016 taxation year has not concluded and there is a remaining open inquiry about the share repurchase transactions
The respondent argued that the Minister’s audit of the share repurchase transactions for 2016 had ended, as the Minister had issued her notice of reassessment in respect of this issue for the 2016 taxation year.
The respondent submitted that a reassessment by the Minister or a notice of objection to the reassessment led to an impartial review by the CRA Appeals Division, which is a separate process with different information-gathering powers.
As the file was now with the CRA Appeals Division, the Respondent submitted that the Minister was out of time to use her audit powers to seek production of the MSPM under section 231.1 and 231.7 of the Act.
In responding to these arguments, Justice Kane emphasized that there are no time limits for the Minister’s exercise of her authorities pursuant to section 231.1 or 231.7. Additionally, Justice Kane did not agree “that the audit ended with the Minister’s notice of reassessment (June 2021)” nor did she agree that the “notice of objection puts an end to the Minister’s authority pursuant to sections 231.1 or 231.7.” On this basis, Justice Kane indicated that requests for information are not restricted to the pre-assessment period.
Even if the redacted MSPM constitutes TAWPs, it should be produced
The respondent submitted that the redacted MSPM constitutes TAWPs and relied on BP to argue that its production should not be compelled. In BP, the Federal Court of Appeal concluded that allowing the Minister unrestricted access to TAWPs, without having to advance any particular justification for their production, would impose on taxpayers a requirement to routinely provide the Minister with their uncertain tax positions every year. This would, in effect, compel taxpayers to “self-audit.” In determining that the Minister is precluded from having general and unrestricted access to TAWPs on a prospective basis, the Federal Court of Appeal stated that the “the Minister cannot enlist taxpayers who maintain TAWPs to perform the core aspect of audits conducted under the Act.”
Justice Kane emphasized that subsequent jurisprudence has clarified that, when requested in the context of an active audit of particular issues, and where the production of the TAWP would not offend the principle that a taxpayer is not required to self-audit, TAWPs may be produced (see Canada (National Revenue) v Atlas Tube Canada ULC, 2018 FC 1086).
Justice Kane concluded that, to the extent that the MSPM constituted TAWPs, it had not been established that its production would impose an obligation on the respondent to self-audit into the future or that its uncertain tax positions would be revealed. Further, Justice Kane stated that its production should be allowed as it was sought for the specific purpose identified in the 2016 audit regarding the share repurchase agreements.
Ordering production of the MSPM does not improperly undermine the discovery process or circumvent the discovery rules in the Tax Court of Canada
In responding to the respondent’s concerns that the production of the MSPM would improperly undermine the discovery process or circumvent the discovery rules in the Tax Court of Canada, Justice Kane simply concluded that the Tax Court of Canada can address the scope of discovery in the context of those proceedings and can address any argument that the production of the MSPM has prejudiced Investmentco or its indirect parent in their appeals with respect to their 2012 taxation years.
Lessons learned
The respondent in this case appealed to the Federal Court of Appeal in March 2022. While the reasoning and analysis of Justice Kane appears sound, it will be interesting to see whether the Federal Court of Appeal agrees with her conclusions, especially the conclusion that the audit does not end when the reassessments are issued.
Of particular interest will be whether the Federal Court of Appeal addresses the issue of how the information set out in the MSPM can be said to be relevant for a “purpose related to the administration or enforcement of the Act,” a requirement under the relevant sections of the legislation.
Given that the CRA had already assessed the relevant taxation year, how can it be said that the redacted amounts — amounts the taxpayer recorded as a reserve — have any relevance in determining the amount of tax payable by the taxpayer? Very simply, if a taxpayer determined, based on legal advice, that they did not owe any tax in respect of a particular issue, and the CRA reassessed the taxpayer $100 of tax in respect of that issue, how is the taxpayer’s calculation of its reserve relevant in determining the correct amount of tax payable? The tax is either $0 or $100. What the taxpayer set up as a reserve has no bearing on that issue.
Further, while the current outcome from the Federal Court’s decision is frustrating for taxpayers — essentially indicating that the CRA may still use its audit powers to gather information and documentation from the taxpayer when the matter at issue has already been assessed and the issue is in the hands of CRA’s Appeals Division — taxpayers should keep in mind that they too can rely on the Access to Information Act to compel further disclosure from the CRA in the course of the objection and appeals process.
Finally, for certain corporate taxpayers, this issue will to some extent become moot. As noted in EY Tax Alert 2022 No. 3, the Federal Government has released draft legislation introducing certain mandatory disclosures rules. These include proposed rules to take effect in 2022 requiring certain corporate taxpayers to report particular uncertain tax treatments to the CRA. These proposed rules would apply to a corporation that is required to file a Canadian income tax return for the particular taxation year, has at least $50 million in assets at the end of the last financial year and the corporation or its consolidated group has audited financial statements in which uncertainty in respect of the corporation’s Canadian income tax for the taxation year is reflected.