F.K. Clayton Group Ltd. v. MNR, 88 DTC 6202, [1988] 1 CTC 353 (FCA)

Hugessen, J.:—This is an appeal and a cross-appeal from a decision of Walsh, J., [reported at [1986] 2 F.C. 105; [1986] 1 C.T.C. 470]. By that decision the trial judge found paragraph 231(1)(d) and subsection 231(2) of the Income Tax Act, as they then read, to be of no force and effect as being inconsistent with section 8 of the Charter. He quashed an application for retention made by the Minister pursuant to section 231(2) but declared that such quashing was not to be construed as a collateral attack on an order for retention made by a County Court judge pursuant to such application. He found the seizure, although illegal, not to have been unreasonable and he ruled that the documents seized need not be returned until they were produced in court proceedings.

The appellant taxpayers appeal against those parts of the trial judge's order dealing with the reasonableness of the seizure and the return of the seized documents. The Minister’s cross-appeal attacks those parts relating to the adequacy of the relevant provisions of the Income Tax Act in light of the Charter and the quashing of the application under subsection 231(2). It is logical to deal first with the issues raised by the cross-appeal and only subsequently with those raised by the appeal, if that is found to be necessary. The case was argued before us on that basis.

The background is simple. In the course of an audit of the books of the appellant F.K. Clayton Group Limited for the years 1978 to 1982, the Minister's auditors became suspicious that certain expenses charged to the company had, in fact, been for the personal benefit of the controlling shareholder, the appellant F.K. Clayton. In accordance with apparently routine departmental practice, the matter was turned over to a “special investigator", Mr. R.O. Bailey. Mr. Bailey, after making an extensive review of the auditor's worksheets and conducting other investigations, concluded that there was indeed matter for further enquiry. He arranged to meet with Mr. Clayton at the Clayton company's offices on December 21, 1983. In the course of that day, he confronted Mr. Clayton with a number of the suspect entries and obtained from him an admission not only that the expenses in question were personal rather than business expenses of the company but also that at least one invoice had been prepared by him to falsely represent a business expenditure of $10,000 which was, in fact, used to purchase a boat for his personal use. On the following day, December 22, the two met again and Mr. Bailey obtained from Mr. Clayton a number of further admissions regarding other expenses charged to the company's account which had, in fact, been for his own personal benefit. It appeared to Mr. Bailey that he was dealing with a case of violations under section 239 of the Income Tax Act and that those violations indicated a pattern of wilful conduct on the part of the taxpayer aimed at misrepresenting the amount of taxes payable. Mr. Bailey decided to seize the books and records of the company pursuant to paragraph 231(1)(d). In an affidavit filed in the Trial Division, he describes his reasons for doing so as follows:

22. I believed that in the circumstances where the taxpayer had been directly confronted with the evidence of improperly deducted and misrepresented expenses, it was necessary to secure the books, records and other documents which were or may be evidence because they may not have been safe if left in the possession of the taxpayers. (Appeal Book, at page 52).

The seized documents filled two boxes. They appear to comprise most of the accounting and banking books and records of the company for the years 1978 through 1981 inclusive, although some of the documents go back to as early as July 1973 and others are dated as recently as November 1982.

On a subsequent application, pursuant to subsection 231(2), a County Court judge granted an order

. . . THAT the documents, books, records, papers or things referred to in the above application made on behalf of the Minister of National Revenue be retained by him until they are produced in any court proceedings.

The relevant portions of the Income Tax Act have since been amended. At the time of the events here in issue, however, they read as follows:

231. (1) Any person thereunto authorized by the Minister, for any purpose related to the administration or enforcement of this Act, may, at all reasonable times, enter into any premises or place where any business is carried on or any property is kept or anything is done in connection with any business or any books or records are or should be kept, and

(a) audit or examine the books and records and any account, voucher, letter, telegram or other document which relates or may relate to the information that is or should be in the books or records or the amount of tax payable under this Act,

(b) examine property described by an inventory or any property, process or matter an examination of which may, in his opinion, assist him in determining the accuracy of an inventory or in ascertaining the information that is or should be in the books or records or the amount of any tax payable under this Act,

(c) require the owner or manager of the property or business and any other person on the premises or place to give him all reasonable assistance with his audit or examination and to answer all proper questions relating to the audit or examination either orally or, if he so requires, in writing, on oath or by statutory declaration and, for that purpose, require the owner or manager to attend at the premises or place with him, and

(d) if, during the course of an audit or examination, it appears to him that there has been a violation of this Act or a regulation, seize and take away any of the documents, books, records, papers or things that may be required as evidence as to the violation of any provision of this Act or a regulation.

(2) The Minister shall,

(a) within 120 days from the date of seizure of any documents, books, records, papers or things pursuant to paragraph (1)(d), or

(b) if within that time an application is made under this subsection that is, after the expiration of that time, rejected, then forthwith upon the disposition of the application,

return the documents, books, records, papers or things to the person from whom they were seized unless a judge of a superior court or county court, on application made by or on behalf of the Minister, supported by evidence on oath establishing that the Minister has reasonable and probable grounds to believe that there has been a violation of this Act or a regulation and that the seized documents, books, records, papers or things are or may be required as evidence in relation thereto, orders that they be retained by the Minister until they are produced in any court proceedings, which order the judge is hereby empowered to give on ex parte application.

At the outset, it must be borne in mind that the appellants’ Charter-based attack was and is limited to the power of seizure granted by paragraph 231(1)(d) and the concomitant power of retention granted by subsection 231(2). Neither at trial nor on appeal did the appellants take issue with the rights of audit and examination granted by paragraphs 231 (1)(a), (b) and (c). Those rights are clearly very closely akin to a right of search. They undoubtedly represent a substantial intrusion upon the privacy of the subject which is protected by section 8 of the Charter. Any assessment of their validity would have to balance the prima facie unreasonableness of a warrantless search against the need for some sort of random compulsory audit in any self-reporting and self-assessing tax system. Although the present case does not require us to undertake that balancing process, I find particularly apposite the words of Burger, C.J. in United States v. Bisceglia, 420 U.S. 141 (1974) at 145-46:

We begin examination of these sections against the familiar background that our tax structure is based on a system of self-reporting. There is legal compulsion, to be sure, but basically the Government depends upon the good faith and integrity of each potential taxpayer to disclose honestly all information relevant to tax liability. Nonetheless, it would be naive to ignore the reality that some persons attempt to outwit the system, and tax evaders are not readily identifiable. Thus, § 7601 gives the Internal Revenue Service a broad mandate to investigate and audit "persons who may be liable” for taxes and § 7602 provides the power to "examine any books, papers, records, or other data which may be relevant . . . [and to summon] any person having possession . . . of books of account . . . relevant or material to such inquiry." Of necessity, the investigative authority so provided is not limited to situations in which there is probable cause, in the traditional sense, to believe that a violation of the tax laws exists. United States v. Powell, 379 U.S. 48 (1964). The purpose of the statutes is not to accuse, but to inquire. Although such investigations unquestionably involve some invasion of privacy, they are essential to our self-reporting system, and the alternatives could well involve far less agreeable invasions of house, business, and records.

Where, as in the present case, the audit (search) has already taken place and its validity is not questioned, the privacy interest protected by section 8 is clearly somewhat diminished. Thus, although the decision of the Supreme Court in Hunter v. Southam Inc., [1984] 2 S.C.R. 145; 84 D.T.C. 6467, must remain the leading authority on the limits of what the Charter permits in searches and seizures, there are some distinctions that must be made. In some respects, the position is analogous to that dealt with in this Court's decision in Bertram S. Miller Ltd. v. R., [1986] 3 F.C. 291.

In Southam, the protection of privacy was controlling: the impugned warrant authorised the search at large into books and records which were otherwise utterly unaccessible to officials and in which Southam had every reasonable expectation of privacy. In Miller, there was no privacy interest whatsoever remaining to be protected: a consensual search (inspection) had revealed the existence of dangerous parasites in nursery stock and the issue was whether officials could, without warrant, proceed to the destruction of the stock to prevent the pest from spreading. Here, as I have indicated, the appellants’ privacy interest in their accounting books and records is diminished by the fact that officials of the Department of Revenue have already examined them in detail. This is not to say, however, that the privacy interest has altogether disappeared as it had in Miller: the Income Tax Act requires substantial disclosure by taxpayers and authorises extensive investigation by Department officials but it also imposes on the latter a strict and onerous obligation of secrecy. What is revealed on a tax return or learned on a tax audit may not be disclosed except as specifically provided by law. Section 241 of the Income Tax Act provides detailed rules to ensure secrecy and penalties for their breach.

In my view, the citizen who is subjected to a tax audit has an interest in the protection of the confidentiality of the results of that audit quite as much as he does in his income tax returns themselves. Unless and until court proceedings are brought, the taxpayer is entitled to expect that his personal financial affairs will remain private. Thus his privacy interest, while perhaps not quite as high as the one recognised in Southam, is still very substantial indeed.

Privacy, however, is not the only interest protected by section 8. As the reasons for judgment in Southam demonstrate, the rule requiring that searches be previously authorised by warrant had its origins in the need to protect property rights. In the present case, the appellants have an important property interest in the things seized which are, by definition, the books and records of the business carried on by them. I believe we should take judicial notice of the fact that the seizure of such books and records and their physical removal from the company's business premises is bound to have the most serious repercussions on its ability to carry on its business.

All these things being considered, it is my opinion that the trial judge properly found paragraph 231(1)(d) and subsection 231(2) to be contrary to the guarantee against unreasonable search and seizure contained in section 8.

In the first place, the seizure, being warrantless, is prima facie unreasonable; it does not have the prior sanction of an impartial arbiter “capable of acting judicially". [1]

Secondly, the legislation sets no objective standard against which to test the validity of the seizure. The words of paragraph 231(1)(d) authorise the official to make a wholly subjective assessment of the need to seize:

... if... it appears to him . ..

Thirdly, the standard which is set by the legislation is far too low, requiring only the appearance of a violation to justify the seizure. As was stated in Southam,

The state's interest in detecting and preventing crime begins to prevail over the individual’s interest in being left alone at the point where credibly-based probability replaces suspicion. (at page 167; D.T.C. 6477).

In this respect, paragraph 231(1)(d) may be contrasted unfavourably with subsection 9(4) of the Plant Quarantine Act, R.S.C. 1970 c. P-13, dealt with by this Court in Miller, which required as a condition of seizure the formation of belief on reasonable grounds that the matter to be seized constituted a hazard.

Fourthly, it is my view that the scope authorised by paragraph 231 (1)(d) is too broad. As interpreted by the Minister, once a violation of the Act or Regulations has taken place, the paragraph authorize(s) the seizure of records that

may be required as evidence as to the violation of any provision of the Act.

This is precisely the type of provision which has already been found by this Court to fall foul of section 8: [2]

However, I cannot accept the general proposition that the mere fact that a taxpayer has, at a particular time, committed an offence under the Income Tax Act or the Regulations, however trifling that offence, affords sufficient justification for the general power of search and seizure conferred by subsection 231(4). In my view, that subsection violates section 8 of the Constitution Act, 1982 in that it contravenes the right of the taxpayer "to be secure against unreasonable search or seizure.”

Fifthly, there is no requirement in the statute limiting the seizure to urgent cases where a failure to seize might result in the loss or destruction of important evidence. Nor do the facts of this case support counsel's suggestion that there was in reality any such urgency. It will be recalled that Mr. Bailey’s affidavit, quoted above, asserts that the confrontation with the taxpayer had made it necessary to seize the documents. But Mr. Bailey himself had provoked that confrontation. I cannot accept that officialdom can create its own emergencies and then use them to justify a seizure of property. It will also be recalled that during the so-called confrontation, Mr. Clayton had admitted virtually every allegation which was made against him. Since the evidence shows that Mr. Bailey came to the meeting with the boxes necessary to carry off the seized documents already in his car, one wonders what possible responses Mr. Clayton might have made to Mr. Bailey's questions which would have had the effect of averting the "emergency".

Finally, on this aspect of the matter I would note that this is not a case where the statute provides an opportunity to contest the seizure before it takes place, such as was before the Supreme Court of the United States in Bisceglia, supra. Even subsection 231(2), allowing for the retention of the documents after they have been seized, specifically provides that the judicial authorisation may be obtained ex parte. Cases in this country dealing with subpoenas duces tecum [3] are thus of no assistance to the respondent.

The only remaining issue to be dealt with on the Crown's cross-appeal is that part of the trial judge's order which quashed the application for retention made pursuant to subsection 231(2). With respect, the trial judge was in error here. In the first place, at the time that he gave his order, the application had already been acted upon and an order issued pursuant thereto. The application was thus spent and the order quashing it was ineffective. More important still, the application was made to a judge appointed under section 96 of the Constitution Act and having jurisdiction under the statute. The trial judge had no jurisdiction to quash proceedings before such a judge. It is, of course, the case that the effect of the finding that subsection 231(2) is of no force and effect is to render the County Court judge's order nugatory but the form of the order chosen by the trial judge was wholly inappropriate.

This brings me to the principal appeal, relating to the disposition of the seized documents. It will be recalled that the trial judge made a finding that the seizure was not unreasonable; based on that finding he ruled that the documents need not be returned. In my opinion, both the finding and the ruling are clearly wrong.

In the first place, as a matter of law, I do not think that a seizure whose sole justification in law is a provision which is found to be unreasonable can itself be said to be reasonable. The seizing officer may have acted in good faith and in accordance with the law as he then presumably believed it to be, but that cannot make the seizure itself reasonable. It need hardly be added that there can be no justification for the seizure at common law or otherwise than in virtue of the specific text of paragraph 231 (1)(d).

Furthermore, and notwithstanding the trial judge's finding, I cannot accept that it is proper to characterise Mr. Bailey’s action in the present circumstances as reasonable. He was, of course, in good faith and believed the law allowed him to do what he did but, on the showing of his own affidavit, he justified the seizure by a confrontation which was entirely of his own making. Also, as I have indicated, and again no doubt in good faith, Mr. Bailey’s seizure extended far beyond the documents which were necessary to provide evidence of the offences which he, at that time, had reason to believe had been committed.

With respect to the trial judge's refusal to order the return of the documents, it is only fair to point out that his ruling was made prior to this Court's decision in Lagiorgia v. Canada, [1987] 3 F.C. 28; [1987] 1 C.T.C. 424. On this aspect of the matter, that case is, despite counsel's plea to the contrary, controlling: the normal disposition to make on an order setting aside a seizure as being unreasonable in virtue of section 8 of the Charter includes as a minimum an order for the return of the things seized. Counsel asked that we should at least delay the making of such an order until ten days after the entry of judgment; I can see no basis for doing this. If the Crown has a right to seize the documents other than in virtue of paragraph 231(1)(d), then it is free to attempt to exercise it. If the Crown has no such right, the materials should be returned forthwith.

I would only add that an order for the return of the seized documents neither contradicts nor varies the terms of the order given by the County Court judge. That order, which is quoted above, simply allows the Minister to retain the documents “until they are produced in any court proceedings". Clearly the reference to court proceedings is not limited to proceedings before the County Court judge who signed the order. Indeed I do not think it is limited to proceedings in courts in the same province since it is entirely possible that a seizure under paragraph 231 (1)(d) might be carried out in one province and the documents seized be used in proceedings before the courts of another province where a defendant has its head office or principal place of business. There is no question as to this Court's jurisdiction in the present proceedings and that manifestly includes the jurisdiction to order the production and return of the documents.

Finally, on the question of costs, the trial judge awarded none on the basis that success had been divided. That is no longer the case and success both on the appeal and on the cross-appeal has gone almost entirely to the appellants. The Crown's success on the cross-appeal is limited to the technical question of the quashing of the application under subsection 231(2).

Accordingly I would allow the appeal with costs and the cross-appeal without costs. I would strike out all that part of the trial judge's order following paragraph (1) thereof and substitute therefor an order that the documents seized and taken away on December 22, 1983, by the respondent R.O. Bailey, as well as any copies and extracts thereof, be forthwith returned to the appellants. I would further order that the appellants recover their costs of the proceedings in the Trial Division.

Appeal allowed.