The upcoming personal income tax return filing deadline of April 30th brings many things, one of which is increased scrutiny and contact from the Canada Revenue Agency (“CRA”) for many taxpayers. Each batch of filed returns generates fresh requests for additional information from CRA, and in some instances, full blown audits.
Most Canadians will receive CRA correspondence during their lives requesting additional information and clarification on a bevy of points. Often, if handled properly, these may be dealt with in a simple and straightforward manner. However, other times, such contact is the beginning of an audit.
An audit is obviously a stressful process for every taxpayer. Simply put, taxpayers are often ill prepared for the range of documents (or other information) that CRA will state that it requires in order to fulfill its mandate (and the cost and time associated with producing said documents). Further, it is often difficult for citizens to adjust to the often adversarial dealings with CRA in the context of an audit.
In light of the above, the audit process and powers of CRA warrant further comment.
a. First contact
As mentioned above, taxpayers are often shocked by CRA’s announcement they will be audited. Part of this shock stems from the way in which many audits evolve. Most contact from CRA is initiated through a standard, innocuous letter requesting additional information or an opportunity to review a client’s books and records. A particular issue or area of concern may be identified. Once such an issue is spotted, it often serves as the genesis for a larger review or audit. Generally, the request will also be limited to specific taxation years, unless CRA can establish fraud, carelessness, or negligence on the part of the taxpayer. Absent such facts, CRA will only reassess three years from the date of the original assessment (four years for large corporations).
Thus, after an initial provision of documents and some initial discussion (after which the taxpayer often believes the matter has been concluded), CRA may conclude that sufficient issues have been uncovered which warrant further examination. At this point, a request for additional information will often be made. This is often a further shock for the taxpayer, who was not aware that the initial stage could be expanded into a much more involved and costly process.
Thus, throughout this initial stage taxpayers should remain civil in dealing with CRA, but should also take the long view: they should expect that CRA may well broaden its inquiry into a full audit, in particular if a full and satisfactory explanation is not offered (in the eyes of the CRA). To this end, it is often helpful for a taxpayer to involve his or her accountant and a tax lawyer, at the outset to provide a clear understanding of the taxpayer’s rights and to help ensure that a consistent explanation and rationale is provided to CRA.
b. The audit and request for additional information
If an audit is pursued and a requirement for information is made, taxpayers are generally required to provide everything the auditor requests. A “requirement for information” is a letter which legally requires a taxpayer to comply with the request, warning that failure to comply within a specified deadline may result in prosecution.
In reviewing the appropriateness of a request for information, a court will generally ask whether the requested information is for a purpose related to the enforcement of the Act (some cases have, in turn, suggested that it must be part of a “serious inquiry”). Thus, CRA requests for such information are generally successful.
The Supreme Court of Canada has similarly concluded that a taxpayer’s right to privacy in the context of an audit is fairly low, as checks (such as audits) are necessary given the self-reporting structure of our income tax system. As a result, the state must be empowered to ensure that citizens are reporting their income accurately.
c. Third party requirement issues
While CRA generally limits its inquiries to the taxpayer in question, in some circumstances, CRA will go further and address requests for information to third parties that CRA believes are in possession of the relevant information. These third parties may include financial institutions, advisors, and employers of the taxpayer. While institutions and advisors are subject to wide ranging laws which require that every client’s personal information be kept private and secure, such laws are generally overridden by the power of CRA to compel the production of such information.
However, solicitor-client privilege is granted special exception under the law. The underlying rationale for this is that without absolute confidence between lawyers and clients our justice system would not function, as citizens would be unwilling to fully confide in their lawyers and would thus be deprived of full recourse under the legal system. Thus, solicitor-client privilege is a general overriding principle. Further, the Act contains specific exclusions which exempt such documents from production. Thus, while CRA may obtain most documents from a taxpayer, they generally cannot obtain privileged documents (unless privilege has been waived by the client).
d. General comments
In light of the above, the following general comments can be made:
First, taxpayers should treat CRA correspondence, in particular requests for additional information (whether formal requirements for information or not) seriously, and seek the advice of their advisors if required.
Second, while outright refusals to produce information requested by CRA are generally not productive, taxpayers should note that they do have certain rights (such as solicitor-client privilege) which CRA cannot circumvent.
Third, solicitor-client privilege may also be used to protect documents at the planning stage, pre-audit. This is why many clients frequently consult with their lawyer throughout the strategic planning process.
Fourth, and most importantly, taxpayers should always bear in mind that CRA may well expand its initial request into a larger scale audit. To this end, it is critical to be prepared: a larger audit and legal process may be averted where CRA is presented with a solid rationale for every fact and document. As such, taxpayers may wish to consider involving their accountant and tax lawyer earlier in the process, rather than after CRA may have already drawn certain adverse conclusions and it may be too late. Going to Tax Court is an expensive proposition, and the best outcome can often be achieved early in the process by involving the proper professionals.