Supreme Court: The Line Between Tax Audits and Investigations

In its Backgrounder to the new Section 237.3, which defines reportable tax avoidance transactions that may be subject to the General Anti Avoidance Rules, Finance Canada has assured taxpayers that the provision, is for “administrative purposes only” and therefore it is unlikely that it will be used to incriminate a taxpayer. 

It’s useful to look at how the courts have interpreted such potential powers in the past.

In Jarvis [2003], 1 C.T.C 135, the Supreme Court of Canada drew the line between tax audits and investigations. The Court held that once the “predominant purpose” of an inquiry is an investigation for purposes of prosecution rather than assessment, audit powers could no longer be used.  This may be an important distinction with the passage into law of new Section 237.3.

The Court developed a non-exhaustive list of factors to help determine when an audit “crossed the Rubicon” into an investigation:

            a) Did the authorities have reasonable grounds to lay charges? Could a decision to proceed with a criminal investigation have been made?

            b) Was the general conduct of the authorities consistent with the pursuit of a criminal investigation?

            c) Had the auditor transferred his or her file and materials to the investigators?          

            d) Was the conduct of the auditor such that he or she was effectively acting as an agent for the investigators?

            e) Does it appear that the investigators intended to use the auditor as their agent in the collection of evidence?

            f) Is the evidence sought relevant to taxpayer liability generally, or only to criminal liability?

            g) Are there any other circumstances or factor that can lead the judge to the conclusion that the audit had in reality become a criminal investigation?

It is likely that a judge would apply similar considerations under the new provision in order to ascertain the rights of the taxpayer in any impugned transaction or series thereof that the CRA became aware of as a result of a filed RC312 form.

Under subsection 5(2) of the Privacy Act, when a government institution collects an individual's personal information from the individual, it must inform the individual of the purpose for which the information is being collected and under Section of that act, personal information under the control of a government institution may be used only for the purpose for which the information was obtained or for a use consistent with that purpose, unless the individual consents.

Another saving grace is that solicitor-client privilege does not fall under the rubric of “confidential protection”, as defined for the new section 237.3. Therefore, a lawyer who is an advisor regarding a reportable transaction is not required to disclose in an information return any information for which the lawyer asserts, on reasonable grounds, is privileged.

Furthermore, a sub-set of solicitor client privilege known as litigation privilege or “solicitor’s brief” prevents a lawyer from having to disclose information and documents which are furnished in contemplation of a court action. This aspect of solicitor client privilege could potentially exonerate a taxpayer from the full reporting requirements of 237.3.

The interplay of the new provision with the pre-existing broad based rules, such as the general anti-avoidance rules (GAAR) will be interesting to see. It is clear that Parliament wanted to equip the CRA with stronger tools to fight their battles in a world that is growing increasingly complex by the day. The problem for the CRA will be using this information to prosecute taxpayers for evasion. 

The difficulty for taxpayers is that simply identifying avoidance transactions or a series thereof is going to prove very difficult, and expensive. It is likely that the new provision will act more as a general deterrent from aggressive tax planning than anything else.

Greer Jacks is updating jurisprudence in EverGreen Explanatory Notes, an online research library of assistance to tax and financial professionals in working with their clients.