CRA’s Access to Tax Accrual Working Papers

Download PDF

CRA’s Access to Tax Accrual Working Papers

BP Canada Energy Company v MNR, 2017 FCA 61

EDITORIAL NOTE – The FCAs reasoning in this decision – that interpreting subsection 231.1(1) as giving the Minister the power to have routine access to a taxpayer’s uncertain tax positions would interfere with provincial financial disclosure laws – is unsound.  Persons are expected to abide by all laws that apply to them and it seems problematic for a court to read down one law because taxpayers may then fail to abide by other laws. Such legal-arbitrage by taxpayers should not be condoned.  It is interesting to see what the SCC will decide if this decision is appealed and how parliament will react to such a decision.  

The Federal Court of Appeal considered whether or not the Federal Court (2015 FC 714) was correct in ordering BP Canada to produce internal accounting documents (Tax Accrual Working Papers) to the Minister pursuant to subsection 231.7(1) of the Income Tax Act for purpose of assisting the Minister in conducting an ongoing audit of the taxpayer.  The Federal Court of Appeal rules that “the documents ordered to be produced, given the purpose for which they were sought, are beyond the reach of the Minister” (para 4).

Tax Accrual Working Papers are highly sensitive and often contain uncertain tax positions taken by public corporations in filing their tax returns as well as opinions as to the likely outcome should such positions be challenged by the CRA.  This information is then used to take tax positions, and to establish reserves to ensure sound and fair financial reporting.  In this case, the taxpayer refused to comply with the order, taking the position that “disclosure of its Tax Reserve Papers would not only provide the Minister with a roadmap to its uncertain tax positions, but the Minister would also gain access to the analyses behind those positions” (para 10).

ANALYSIS

The court began by outlining the type of information contained in TAWPs as:

  • papers created for independent auditors to assist with the process leading to the certification of financial statements in accordance with GAPP;
    • this is a requirement imposed under provincial securities legislation;
  • their purpose is to identify uncertain tax positions;
    • these are positions that are capable of being successfully challenged by the Minister;
    • they contain an opinion as to the likely outcome of a challenge;
  • uncertain tax positions are used to 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;
    • the reserve is meant to neutralize the distortion that results from the position;

The FCA also agreed that subsection 231.7(1) could not have been drafted in broader terms, but the use of this apparently broad power must relate to the Minister’s administration or enforcement of the ITA.  In this case, the Minister wants access to the TAWPs to facilitate audits, and this appears to be an authorized purpose.

Once it is shown that the Minister is acting for an authorized purpose, the court must look for one of three demonstrations to trigger the application of 231.1(1):

  • The document being sought is part of, or is in, the books and records of the taxpayer;
  • The document being sought relates or may relate to the information that is or should be in the books and records of the taxpayer; or
  • The document being sought related or may relate to any amount payable by the taxpayer under the Act.

Although uncertain tax positions in TAWPs are not recorded by reason of an obligation arising under the ITA, they relate or may relate to information that is in the books and records of the taxpayer.  The requirement to disclose any document that relates or may relate to information that can be found in the books or records kept under the ITA must be necessity include documents other than those that are required to be kept under the ITA.  However, the FCA stated that the issue is not “whether the information revealed by BP Canada’s Tax Reserve Papers could be accessible under the Act” but rather whether subsection 231.1(1) “allows general and unrestricted access to this information” (para 67).

The auditor sought access to the details of the TAWPs after discovering that the tax at risk amounts identified by the taxpayer were significantly higher than the amounts the auditor proposed to add to the taxpayer’s income.  The documents were sought to complete the audit and make the audit more cost efficient.  The Minister took the position that the uncertain tax positions should be seen as aggressive positions given that they were risked at 100%, but the Court noted that there is “no correlation between this percentage and the soundness of the positions to which it relates”  as reserve optimization is a conservative approach to financial reporting (para 77).

The Federal Court of Appeal disagreed with the Federal Court and stated:

80]  In my view, subsection 231.1(1), properly interpreted, does not make papers such as these compellable “without restriction”. When one examines the context and purpose of subsection 231.1(1), it is clear that Parliament intended that the broad power set out in subsection 231.1(1) be used with restraint when dealing with TAWPs. It follows that the decision of the Federal Court judge must be set aside.

The FCA referred to the nature of the Canadian tax system – being a self-assessment system – and said that although taxpayers are required to self-assess, this “does not require taxpayers to tax themselves on amounts which they believe not to be taxable” (para 82).  Where an issue is reasonably up for debate, taxpayers are entitled to file their tax returns on a basis that is most favourable to them (para 82).  Auditors must be left to their own initiative in verifying amounts reported by taxpayers and, although entitled to be provided with all “reasonable assistance” (paragraphs 231.1(1)(d)), “they cannot compel taxpayers to reveal their ‘soft spots'” (para 82). To hold otherwise would be to compel the taxpayer to self-audit on an ongoing basis (para 83).

In enacting subsection 231.1(1), the FCA did not believe that it was Parliament’s intention to vest the Minister with sweeping powers that would undermine the obligations imposed by securities legislation requiring reliable financial disclosure (para 87).  The CPA, as intervener, argued that if this unrestricted access to TAWPs  is granted, then:

publicly-traded corporations would, as a direct consequence, tend to refrain from documenting issues for their external auditors and be less candid in disclosing their tax risks [and i]nducing less disclosure of tax risks to auditors is detrimental to Canadians, be they individuals, corporations or governments, as it necessarily results in less protection by reason of the decreased reliability of financial statements.

The FCA referred to two US decisions where access was granted by to TAWPs and courts stated that this would not negatively affect financial disclosure.  The Court distinguished those cases and stated that the US experience shows that general and unrestricted access to TAWPs would negatively impact financial reporting and impose an obligation on taxpayers that they do not have (para 95).  The FCA stated that the Federal and Provincial powers must be read in harmony such that the power granted pursuant to subsection 231.1(1) of the ITA cannot be used to imperil the integrity of the financial reporting system put in place by the provinces (para 98).

This means that the Minister cannot invoke subsection 231.1(1) to gain general and unrestricted access to a taxpayer’s TAWPs, and therefore cannot enlist taxpayer’s who maintain these documents to perform the core aspect of audits conducted under the ITA (para 99).  The Minister does have the power to access TAWPs, but this power cannot be used routinely (para 103).  The FCA also noted that the Minister was acting contrary to its own published policy not to seek routine access to a taxpayer’s uncertain tax positions.

Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3

If you like this website, please share it with others.

Back To Top OR Home

Reasonableness of Business Expenses

Download PDF

Reasonableness of Business Expenses

Peach v The Queen, 2017 TCC 40

There are a number of hurdles to overcome before an expense is deductible for income tax purposes when determining profits of a business under the Income Tax Act.  One hurdle is the limitation imposed by section 67 of the Act, requiring that the expense be reasonable.

In this case, the TCC issued a Redetermination Order after the taxpayer had partial success at the Federal Court of Appeal. The FCA sent the matter back to the TCC to identify what particular expenses were unreasonable and to what extent, as under section 67 the court can reduce or eliminate an expense to make it reasonable. The TCC reviewed each category of expense, the evidence and testimony in relation to each category, as well as submissions by counsel.

ANALYSIS

The Court referred to the Supreme Court of Canada decision in Stewart v. The Queen, 2002 SCC 46, where the SCC at paragraph 57 addressed how a court should approach the reasonableness inquiry:

57 It is clear from these provisions that the deductibility of expenses presupposes the existence of a source of income, and thus should not be confused with the preliminary source inquiry.  If the deductibility of a particular expense is in question, then it is not the existence of a source of income which ought to be questioned, but the relationship between that expense and the source to which it is purported to relate.  The fact that an expense is found to be a personal or living expense does not affect the characterization of the source of income to which the taxpayer attempts to allocate the expense, it simply means that the expense cannot be attributed to the source of income in question.  As well, if, in the circumstances, the expense is unreasonable in relation to the source of income, then s. 67 of the Act provides a mechanism to reduce or eliminate the amount of the expense. Again, however, excessive or unreasonable expenses have no bearing on the characterization of a particular activity as a source of income.

There are certain things that a court is not entitled to consider, including second guessing the business decisions of a taxpayer by asking:

  • whether the expense is the result of poor business judgment – Ankrah v. R., 2003 TCC 413 at paragraph 4, citing Gabco Limited v. MNR, (1968), 68 DTC 5210 (Ex. CF) at page 5216. The primary basis for denial is that no person of business would pay such an amount given the circumstances of the particular taxpayer; and
  • whether expenses exceed revenues as business expenses are incurred before profitability can be determined and for the purpose to gain business income, and cannot be part of the reasonableness inquiry – Williams v. R., 2009 TCC 93 at paragraphs 16 and 17.

The Court considered the following categories of expenses:

  • Meals and Entertainment
    • the court stated that anything beyond $20.00 a day for lunch, when no client meetings are involved, is unreasonable.
    • NOTE – the court considered travel meals under meals and entertainment – not the appropriate category of expenses, and also did not consider the particular circumstances (location, average meal, dietary needs) in setting out a hard line number.
  • Business Tax, Fees and Licenses 
    • these are costs that must be incurred to operate a business and as such are reasonable.
  • Office Expenses
    • the Court determined that absent an explanation for an increase in the subsequent year, the amount in excess of the year previous was unreasonable.
  • Capital Cost Allowance
    • The court determined that without a travel log the expenses were unreasonable
    • The Court also determined that give vehicles were unreasonable
  • Motor Vehicle Expenses
    • The Court held that the operation of five motor vehicles over two years for one person was unreasonable without a justification

Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3

If you like this website, please share it with others.

Back To Top OR Home

Income Tax – HST/GST – International Tax