23 February 2016 Toronto Centre Tax Professionals - Approach to Large Business Audit Compliance - Update
This is a lightly edited transcript of the CRA presentation at the Toronto Centre Tax Professionals seminar on 23 February 2016. The presenters were:
Gord Parr, Director, Large Business Audit Division, International and Large Business Directorate, Compliance Programs Branch
Andrew Kingissepp, Partner, Taxation, Osler, Hoskin & Harcourt LLP
Certain questions that briefly introduced the topics (e.g. "could you tell us about CRA's new approach to risk-assessment") have been edited out.
Compliance Programs Branch (CPB) - Update
Parr: Back in December 2015, there was an announcement that the Clients Programs Branch will be splitting into two branches. Currently our Assistant Commissioner is Ted Gallivan. As you know, Richard Montroy, who had been the Assistant Commissioner for about four years, recently retired. With the changing tax administration environment, there was an opportunity to look at the structure of Compliance Programs Branch, and a decision was made to split it into two branches.
The one branch (name to be determined) is "Compliance, International and Large Business." That will have international aggressive tax planning, large business audits, the criminal investigations Directorate, and also the off-shore program. The other branch will be "Compliance, Small or Medium Enterprise," which will have small-medium enterprise income tax, GST/HST programs, and scientific research and experimental development. The Assistant Commissioner for that branch, effective April 1st, will be Anne-Marie Levesque.
These two branches will allow us to focus on enhancing our efforts to combat tax avoidance and tax evasion, and also allows us to focus on broadening the client-focus direction within the branch, and also support the Agency culture for the service. This is a Headquarters reorganization - it should have minimal impact for field operations. This reorganization will be effective from April 1st, 2016.
Risk Assessment - Large Business
Parr: We've had the approach for large business compliance in place now for about four to five years. It's been very effective for large business audit clients. It basically looks at the taxpayer's compliance-risk, and also promotes responsible corporate tax management behaviour and practices.
Historically, we've had our risk segments divided into three categories: High, Medium, and Low Risk. Approximately three years ago, we started focusing on enhancing our risk assessment systems. We've made some progress in this area, and these risk-assessment systems are used to identify, within those three categories, risk indicators within the taxpayer population. It allows us to focus on the highest-risk cases nationally. Historically, we have had a coverage-based approach to compliance for large business audits. We've moved to a risk-based approach, and our goal is to focus on highest-risk cases nationally utilizing our enhanced risk-assessment systems, which includes the integrated risk-assessment system.
The risk indicators that are identified through our systems are then given to our large-file case-managers, auditors, and industry specialist services. They conduct a further analysis of the risk within the files. They look at inherent and behavioural risk factors. At the end of this process, they come up with a risk-profile for the large business populations, and taxpayers that are within those populations. Those cases that are identified as being highest-risk across the country are then included in regional work plans. There's a regional calibration process that happens in order to ensure that they're comfortable with the cases that are identified for audit. We also have a national work plan and national calibration process. Generally, this is the process that we're moving forward on, and which allows us to optimize our resources and leverage our technical capacity.
(Just as an aside, there has been discussion, and we have presented in the past, on a collaborative compliance initiative. We aren't moving forward with that, within the CRA, but based on our approach to large business compliance, we have most of the pillars that you'll find in other tax-administration enhanced-compliance initiatives, being mutual trust, transparency, cooperation, commercial awareness, responsiveness, and effective tax controls.)
Going back to the tax profiles (high, medium and low risk taxpayers):
- generally those in the high-risk category (generally, those with a history of not being fully transparent and cooperative with the CRA) would be subject to a full compliance audit;
- those in the medium-risk category may be subject to a full compliance audit or issue-based audit; and
- those in the low-risk category may be subject to a compliance-assurance review.
So really, it's a very balanced and targeted approach, and it's based on risk.
Disclosure of Risk Profile to the Taxpayer
Kingissepp: Is there an update on disclosure a taxpayer can get about how its risk-profile is viewed by the CRA?
Parr: We do have a process. What I've described fits in with what we call the National Risk Assessment Model. That information, high-level, is provided to the taxpayer. We do provide information as to what the overall risk factors are in the file, and those factors then become compliance issues or audit issues in the file - that's part of the audit planning - and then that moves on to potential issues that are addressed during the audit, and potential issues that are proposed to the taxpayer. So there's a continuum there between risk-indicators, risk-factors and audit issues, and generally we provide that information to the taxpayer so that they know where they stand as far as overall risk is concerned.
Just one other thing - aligned with the large business compliance, we do have what are called the LBuC meetings. Historically, we tried to cover 100 percent of our large business audit population with these face-to-face meetings. It was very intensive and requires quite a bit of resources; but with our risk-based approach, we're basically doing these LBuC face-to-face meetings with the higher-risk taxpayers. Sometimes, at the conclusion of the audit, based on the results of the audit and on the level of cooperation with the outstanding or re-occurring issues within the file, that information is communicated during such face-to-face meetings The ultimate goal is to have open discussions, and try and reduce the risk for the taxpayer, through voluntary compliance, and also reduce the behavioural risk in the file.
Integrated Large Business Audit Teams
Parr: There was an announcement in September 2014 that the International and Large Business Directorate (for large business audits) would be merged with the integrated large business audit teams. Historically, we've had domestic, international and ATP ["aggressive tax-planning"] programs, and a lot of those were focused on the large business taxpayer segment. They were basically in three different areas within internationalized business programs. The decision was taken with our integrated approach to large business compliance to create these integrated large business audit teams. So basically, the senior auditors from domestic, international and ATP are put into these integrated teams reporting to a large file case-manager. This is effective April 1st, 2016, but most TSOs have already moved to this model.
The auditors in the teams will maintain their specialization - domestic, international and aggressive tax planning (ATP). Overall, this complements our focus on risk-assessment and risk-based approach to large business compliance.
Other benefits from the integrated large business audit teams:
- it reinforces and builds on what we have had for the last four or five years, which is one team, one voice, one audit - so that we have the auditors within one team, and they can work as an integrated group to address compliance issues;
- it also allows for building and maintaining technical capacity within those teams;
- it supports our national inventories, and our movement towards national work plans; and finally
- it should allow us to have a more streamlined approach to conducting the audit, and there will be one point of contact between the taxpayer and CRA, being the large file case-manager.
I'll just mention as well, we have dedicated specialty teams - so not all of the resources within International and ATP are moving into the integrated large business audit teams. We have what are called self-generated workload, mandatory workload, and sometimes there's an omnibus finding that comes in the budget (for example, TFSA) - these workloads are allocated to Aggressive Tax-Planning and, in some cases, international programs. We're still going to maintain what we're calling "dedicated specialty teams," so that for these self-generated/mandatory workloads, we'll still have ATP auditors reporting to a team-leader, international auditors reporting to a team-leader, and they will still be a part of international and large business programs - they're very important - and we'll be leveraging these resources to deal with specific international and aggressive tax-planning issues.
Parr: The workload portability framework has been in place since 2014. We've conducted a number of pilots under this framework, so there was some movement of files within the Ontario region - probably for the most part between the greater Toronto area TSOs. We've also done a pilot between the Prairie region and the Atlantic region, and the results have been very favourable.
National workload is one of our key priorities and, with an enhanced risk assessment, we can move towards national workload. Where, based on risk assessment and the regional work plans, we find that a TSO has more high-risk cases than they can complete based on their current work in progress, based on their resources, based on their technical capacity, and perhaps based on their industry knowledge, those additional cases that are identified will then be considered for workload portability.
Having said that, generally the files will stay within the local TSO. Our goal is to maintain commercial awareness and industry knowledge of those files - some of them very complex industries - so those files generally would not move between TSOs.
There are challenges with workload portability, and maybe you've experienced some of those challenges where you have a team working remotely from the taxpayer. Technology is helping us in this area, probably not so much large business audit but definitely for medium enterprises. There's what is called e-docs where taxpayers have the ability to transmit information through a secure portal to the CRA to facilitate the audit. We also are looking at enhancing our e-services with "My Audit." There isn't an ability currently for CRA to communicate through email. We're not moving in that direction, but we are looking at a portal where taxpayers or representatives can send information or messages into the portal, and then CRA can communicate back out through that portal. So that's something on the horizon, which would facilitate workload portability and working remotely.
And finally, we have been implementing an audit case system within the Compliance Programs Branch. Tax Services Offices are already using this system which allows for storage of data for large business audit, basically an electronic audit file, and that electronic audit file can be made available to, for example, a case manager who's rotating into a large business audit file. So that will facilitate, to some degrees, some of the challenges for workload portability.
Kingissepp: If the audit team is in a different location and, at some point, it becomes desirable to have a face-to-face meeting, I assume that's still possible?
Parr: Yes. Within Canada, travel costs generally are borne by the CRA in order for the audit team to be at the taxpayer's premises. And if there are face-to-face meetings that have to occur, perhaps subsequent to that consolidated audit effort at the taxpayer's premises, then CRA teams, the case manager and the auditors, would be available for a face-to-face meeting.
Parr: As I mentioned earlier, in the past we've had a coverage-based approach to large business compliance. Our rotation policy currently reads that there will be rotation of the large file case manager every three audit cycles, and generally there are two taxation years per cycle, so that's every six years.
We are looking at updating our policy on rotation of large case file manager to every four taxation years under audit. In other words, four taxation years: assessed with the CRA, risk assessed by the CRA and under audit - and at the conclusion of that audit, a new case-manager would be assigned to the taxpayer.
Having said that, we have to ensure that we have maintained a commercial awareness, technical capacity, and industry knowledge, so that when we do rotate case managers, we're going to ensure, especially if it's a complex industry, that the rotating-in manager has that background. As I mentioned, respecting some of the technology features we have coming online for the management of audit files, those electronic files will be available to ensure that there is no significant learning curve, so that the case managers and the team that will be rotating into that file have the technical capacity to undertake that audit work.
Possibility of Original Case-Manager Coming Back
Kingissepp: Let's say a large case file manager rotates off and then a new one comes in for four years - I guess it is possible that the original large case file manager could come back?
Selecting Years for Audit
Parr: We have what's called an Audit Currency Policy - it's not currency as in Canadian dollars or U.S. dollars; it's our own terminology. Basically, a number of years ago, we realized that with a coverage-based approach, we were always playing catch-up. We would always have a number of taxation years under audit; some of them would be old outstanding taxation years. In some of those cases there were low-risk issues, not necessarily high-risk issues, but they would still be in our work in progress.
We've made tremendous strides in the last two or three years to look at our inventory, and what we call "legacy files." So we have these legacy files in our inventory, and there's significant effort within the regions working with headquarters to examine those files. Where the risk is considered low, we'll try and close those files, and what remains would be high-risk, old outstanding years. Our focus is to work with the taxpayers and representatives to try and resolve those issues and finalize those cases.
So our current audit-currency policy is, when we're starting a new taxation year under audit, we'll go with the most recent taxation year that's been assessed with the CRA, risk-assessed by the audit teams - so that the most current year, plus one preceding taxation year, would be audited. If there are recurring issues, if the taxpayer is considered high risk, if the taxpayer has been less than transparent and cooperative with the CRA, then we will consider going back into earlier years to address those high-risk issues. But, generally, it's the most recent year assessed by the CRA and risk-assessed by our large business audit integrated teams and the preceding year that is covered.
Audit-Appeals Revised Protocol
Parr: Anne-Marie Levesque, Assistant Commissioner of Appeals announced at the Canadian Tax Foundation back in November that there is a new audit appeals protocol effective, I believe, January 1st, 2016. We've had a protocol in place for a number of years, and it was decided through discussions between Appeals and the Compliance Programs Branch that we needed to revisit the policy, looking at two categories:
- where substantial information is provided at the appeals stage or at the objection stage, and wasn't provided at the audit stage, and
- where audit has requested the information during the course of the audit and it was not provided at that stage, then at the notice of objection stage, the information is provided, and it's documented in the audit file that this information was requested.
The main change between the old policy and the current policy is to have a mandatory referral process. As I mentioned, where key information is requested during the audit stage, and that information isn't provided (and sometimes there may be a Requirement or Compliance Order that was issued to obtain that information), and then, when audit reassesses the taxpayer, the taxpayer files a notice of objection, and the taxpayer representative provides that information in the objections stage, it's documented in the audit file that the information was requested, and then there is a mandatory process for referral back to audit.
Appeals will maintain their independence and their impartiality. The file is referred back to Audit, Audit will examine the information, and then it will make a recommendation back to the appeals officer. The appeals officer will consider the recommendation, but the ultimate decision-making will rest with the appeals officer, so that the required level of independence will be maintained.
This is the policy going forward, and I would say generally it's advantageous to provide that information during the audit stage where it is a documented request. Then eventually, if it's provided at the objection stage, it will be referred back to Audit for recommendation.
Kingissepp: I think part of it is that the Audit resources are perhaps perceived as being more than at the Appeals level. Is that part of it?
Parr: Yes - generally, there are more resources within the Compliance Programs Branch than Appeals Branch. I don't think that's the driver in this case. Basically, Appeals is responsible, ultimately, for the Notice of Objection. Where Audit has requested the information, they're familiar with the file. There are efficiencies to be gained by having the file referred back to Audit, in light of the audit file which was missing the required information, and for Audit to provide a recommendation. This then goes to the appeals officer and hopefully the case can be expedited.
Disclosure to Taxpayer of Communication Between Audit and Appeals
Kingissepp: Would the communication between Audit and Appeals be disclosed to the taxpayer in some manner?
Parr: If you go to the policy that's on the CRA website right now, the Appeals officer must inform the taxpayer of communications with Audit. So generally that information should be provided to the taxpayer.
Access to Accountants' Working Papers
Kingissepp: This is an area that's been much written about, and I suppose one of the more recent points of interest perhaps started off in June 2010 when the CRA released its policy entitled Acquiring Information from Taxpayers, Registrants and Third Parties. On page 2 of that policy statement, there is a reference to accounting working papers in particular, and it talks about how information from third parties will be sought where the taxpayer cannot or will not provide the information where it is needed by officials to determine the CRA's position on the issue, in accordance with the scope of the review. And then it goes on to say that, for example, since accountants' and auditors' working papers relate to the taxpayer's books and records they may be necessary, although not routinely required, in the determination of a taxpayer's liabilities and entitlements.
The CRA has since clarified (and there was a presentation actually in this room a few years ago) where CRA Headquarters clarified that that the paragraph I was reading from related to information from third parties like accounting firms and that the CRA's view was that they were entitled to the working papers from the taxpayer itself. So that position was contested in the BP Canada case, where the CRA was seeking a compliance order for what were referred to in the judgement as an "issues lists" relating to, in effect, contingency reserves maintained by BP Canada. BP Canada refused to provide the list. The CRA saw the compliance order and the matter went to the Federal Court Trial Division, where the CRA was successful - and that case is currently under appeal to the Federal Court of Appeal. With that background, could you provide us with an update on the CRA's current policy and anything you're able to tell us about the BP case?
Parr: I think this topic comes up quite often during discussions between professional associations and CRA, and obviously this case is of significant interest to tax practitioners. I'm not going to talk about the case itself, as it is under litigation.
Overall, it does support the existing policy that we have in the CRA, that in certain circumstances the CRA has the ability and has the authority under the Income Tax Act to request this information. Again, this case is before the courts, but the decision so far supports our general policy that we can request this information.
Our policy (which we communicated briefly to the regions back in December of 2015 to reiterate it) is that auditors should attempt to collect the information from the most direct source, and in the least intrusive manner. So if the source documentation is available in the taxpayer's books and records, and there's open and transparent disclosure of the uncertain tax positions, there's a level of cooperation and mutual trust, and the CRA is getting the information it needs to determine whether taxable income is understated or the tax balance is overstated - if that evidence and that information is available, then generally we wouldn't request access to the taxpayer's or the accountants' working papers. But, where we can't get that direct information in those situations where there is a high risk issue, then we will request that information.
The request has to be relevant to the outstanding issues, so we're not in a position to make a blanket request for access to the accountants' working papers and, as I mentioned before, it's got to be within the scope of the audit, and relevant to the outstanding issues that are involved in the taxpayer's file.
Generally we're following our policy - our policy hasn't changed. We'll all wait for the decision at the Federal Court of Appeal. But, in our view, the existing jurisprudence supports our general policy that we can request this information in certain circumstances - but our main direct approach would be to work with the taxpayer or representative, and get the information that we need in order to resolve and finalize outstanding issues.
Transfer Pricing Update
Parr: CRA and Finance have been involved in the OECD BEPS initiative. As you know, Canada has endorsed, as part of the G20, the BEPS initiative overall. There are BEPS action items that have them released to the public, and they set out common rules between countries; they provide a tighter adherence to international rules; there's enhanced exchange of information; there's improved dispute resolution; and I believe there are 15 action-items.
CRA and all of us are waiting for policy direction from the Department of Finance and Government of Canada - we're not in a position to move forward with implementation of BEPS until we get that policy direction. So we are still waiting for (and I'm not sure when it's going to come out - in the next few months) this policy direction; but when it does happen, then the CRA will take a leadership role in implementing the action-items that are supported by the policy statement; and at that time we'll be in the position to communicate further on our implementation plans for that. I know that there probably has been some discussion, and you may ask the question, so maybe I'll let you ask the question first. [Laughter.]
Perception that BEPS is Being Applied
Kingissepp: There is some perception that BEPS is already in the process of being applied by auditors - could you comment on that?
Parr: As far as I understand, there hasn't been a policy change in the application of, for example, section 247 and transfer pricing rules and transfer pricing penalties. Our current policy is available, and it's included on the CRA website in the transfer pricing memorandums, and this hasn't changed. So as far as I am concerned, there has not been a change in policy and how we apply the rules in the policy.
Obviously, if there is further policy direction provided, we'll have to reconsider these specific policies and move forward with the implementation of BEPS.
Recharacterization and Penalty Referrals
Kingissepp: The second area we wanted to cover on transfer pricing has to do with recharacterization and penalty-referrals under the subsection 247(2). As I expect many in the audience are aware, for those referrals, a recharacterization or a penalty can't be decided upon by the local audit team. Those issues are mandatory referrals to the Transfer Pricing Review Committee in Ottawa. When this rule first came out, it probably wasn't seen as being as common as it turned out to be in terms of getting recharacterizations approved or penalties imposed from the practitioner's perspective. So I'm wondering if you could provide us with an update on CRA's policy, and how the CRA views that issue.
Parr: It's my understanding that cases that are referred to the Transfer Pricing Review Committee involve the application of penalties; they also involve recharacterization cases. We've had the Review Committee in place for a number of years. They look at each case on a case-by-case basis: they look at the facts, they look at the analysis, and then they consider whether the transfer pricing penalty should be applied, and whether the recharacterization provisions should be applied.
There hasn't been any change in policy in the application of these provisions. Overall, there hasn't been an increase in the percentage of taxpayers where we are applying these penalties.
I'm not sure if there's perception or not, but as far as I'm aware, in consultation with my colleagues and the International Tax Division, there hasn't been a change in policy and in the application of the rules, and there hasn't been an increase in the application of the transfer pricing penalties.
Trend to Move Towards Binding Arbitration
Kingissepp: And the last issue that we wanted to address was: there seems to be a trend now in tax treaties and the competent authority area to move towards binding arbitration where the competent authorities aren't able to agree and, in particular, we've had binding arbitration under the Canada-U.S. Treaty now for a few years. Now that we've had that in place for a few years, I'm wondering if you can give us a sense as to how that's working from the CRA's perspective and any thoughts you can share with the audience on that.
Parr: That's correct. We've had the Fifth Protocol and arbitration available for a few years now. I know my colleague Sue Murray, who was the director of Competent Authority Services Division, has been asked the question before. We don't have statistics on arbitration - the two competent authorities do not release statistics on arbitration. These haven't been released in the past and I'm not in a position to release the statistics today.
Having said that, there are very few cases that end up in an arbitration situation. Both countries take their responsibilities and obligations very seriously to resolve cases within the required time frames/time thresholds. By respecting these time frames, this reduces the need for arbitration and, therefore, hopefully there's resolution on double-taxation on a timely basis and tax certainty for the taxpayer. This is probably the biggest benefit to having arbitration, as it does enforce the time frames that are required.
Respecting the MAP [Mutual Agreement Procedure] program, there is general information on the CRA website, so I encourage you to go there for the annual MAP report that gives you quite bit of information on the overall program with respect to mutual agreement procedures.
And one more thing on competent authority and double taxation - notwithstanding that there is an audit settlement or notwithstanding that the taxpayer/representative agrees with the audit adjustments, where there is a double-taxation, MAP is still available for the taxpayer. So if there's tax on the other side with another tax authority, you have the full right to request relief under the Treaty under the MAP program.