Citation: 2011 TCC 211
Date: 20110415
Docket: 2010-1252(IT)I
BETWEEN:
RICHARD A. KANAN CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
INTERIM REASONS
Campbell J.
[1]
Richard A. Kanan Corporation (the
“Appellant”), appeals reassessments of its 2006 and 2007 taxation years in
which the Minister of National Revenue (the “Minister”) denied the deduction of
certain legal and accounting expenses. The issue raised by this appeal concerns
the interplay between the Appellant’s onus to prove the deductibility of its
expenses and its fundamental and substantive right to the confidentiality of
its communications with its legal counsel. The question may be phrased this
way: how much information can the Minister, or the Court, require a taxpayer to
produce in support of his or her expenses, if that information is subject to
solicitor-client privilege?
[2]
The Appellant’s position is that a
taxpayer’s onus to prove its expenses does not require it to disclose any
privileged communication. The Respondent’s position is that full disclosure of
the lawyer’s file is required to allow either the Minister, via his
representatives in the Canada Revenue Agency (the “CRA”), or the Court to
conclude that legal expenses are deductible. For the reasons that follow, neither
of these positions can be accepted.
Background
[3]
The Appellant is a British
Columbia corporation that operates a dental practice in Invermere, British Columbia.
[4]
Olson Lemons LLP (“Olson Lemons”)
is a Calgary law firm that acts as counsel to the Appellant. Olson
Tax Consultants Inc. (“Tax Consultants”) provides various accounting services,
including the preparation of tax returns. The expenses at issue were incurred
for work done by Olson Lemons and Tax Consultants.
[5]
Thomas Olson, a partner at Olson
Lemons, testified on behalf of the Appellant. He advised the Court that the
Appellant had not waived solicitor-client privilege, and so his testimony would
be limited to unprivileged information.
[6]
Wyndam West, an auditor from the
Southern Interior B.C. Tax Services Office of the CRA (the “Penticton
office”), testified for the Respondent. Mr. West took over when the original
auditor on the Appellant’s file, Mr. Gay, was transferred to another
department. Mr. West completed the audit and finalized the audit report, a copy
of which was produced at the hearing.
The
Audit Process
[7]
According to Mr. Olson, Olson
Lemons regularly assists its clients in responding to CRA’s audits. When
informed that a client is the subject of an audit, Olson Lemons assembles and
organizes all of the relevant documents and invites the auditor to come to its
offices in Calgary. The firm makes space available for the auditor, and
it assists the auditor by finding documents, copying documents, and answering
questions. Mr. Olson testified that Olson Lemons assists its clients in more
than twenty-five audits per year, and that its method of handling audits works
well, regardless of where in Canada the client is located.
[8]
However, in the audit of the
Appellant, the CRA declined the invitation to attend at the Calgary offices
of Olson Lemons. The Penticton office took the position that the conduct of an
audit for a British Columbia corporation should not require the auditor to leave
the province, and that the file would not be transferred to an auditor based in
Calgary. Rather than travel to Calgary, Mr. Gay travelled from Penticton to
the dental office of the Appellant in Invermere, British Columbia. He made this trip despite having
been informed that the dental office would not have room for him to work and
that original copies of the relevant documents were at the offices of Olson
Lemons in Calgary.
[9]
Mr. West’s evidence was that CRA
reluctantly agreed to conduct the audit based on photocopied documents provided
by Olson Lemons. He received copies of the corporate minute book, the general
ledger, invoices for the expenses in question, and receipts for other expenses.
As a result, Mr. West was satisfied that all of the transactions performed by
the Appellant were reported correctly, and that all of the deductions, except
those at issue, were properly taken.
[10]
Of the relevant corporate records,
only the T2 corporate tax returns and the invoices for the expenses at issue
were introduced into evidence at the hearing. Neither party sought to adduce
the Appellant’s minute book or general ledger. Each invoice from Olson Lemons
to the Appellant confirms the amount paid by the Appellant “For Legal Services
Rendered”; however, they contain no further information about what legal
services were provided.
The Submissions
[11]
The Appellant acknowledges that it
bears the burden of proof in this Court; however, it submits that taxpayers
should not be required to reveal any privileged information in order to meet
that burden. It argues that Mr. Olson’s testimony, without revealing any
privileged communications, has succeeded in demolishing the Minister’s
assumptions. Therefore, the appeal should be allowed.
[12]
The Respondent relies on
paragraphs 18(1)(a) and 18(1)(b) of the Income Tax Act (the “Act”),
and argues that Mr. Olson’s evidence contained insufficient detail about the
work done to satisfy the Court that these expenses are deductible.
[13]
In the alternative, the Respondent
invokes the doctrine of implied waiver, arguing that “Mr. Olson’s testimony is
tantamount to waiver of privilege.”
That is, the Appellant should not be allowed to reveal only the privileged
information which supports its case, while keeping the balance confidential. To
do so would prevent the effective scrutiny of the evidence and render the
hearing unfair.
Analysis
[14]
I will address these two
submissions in turn:
1) Can the Appellant meet its onus without
disclosing privileged information?
2) If the Appellant relies on privileged
information to meet its onus, will an implied waiver be found over its entire
legal file?
Can
the Appellant meet its onus without disclosing privileged information?
[15]
The Appellant acknowledges that it
has the initial onus to demonstrate the deductibility of its expenses. However,
it argues that, if solicitor-client privilege was required to be waived in
order to support the deduction of legal fees, it would be explicitly set out in
the Act. The Act does not explicitly abrogate privilege; rather,
Parliament has taken steps to preserve the privilege.
[16]
Information covered by solicitor-client
privilege is given special protection in the Act in the context of CRA’s
investigative powers.
However, the general scheme of the Act requires taxpayers to provide
evidence to demonstrate the deductibility of their expenses. Accepting that the
Act protects rather than abrogates solicitor-client privilege, the
question remains: can a taxpayer satisfy the onus of proving a claim for legal
expenses without revealing privileged information?
[17]
Legal expenses, like other
expenses, are subject to the restrictions of subsection 18(1) of the Act.
Of particular interest are paragraphs 18(1)(a) and 18(1)(b):
18.
(1) In computing the income of a taxpayer from a business or property no
deduction shall be made in respect of
(a) an
outlay or expense except to the extent that it was made or incurred by the
taxpayer for the purpose of gaining or producing income from the business or
property;
(b) an outlay,
loss or replacement of capital, a payment on account of capital or an allowance
in respect of depreciation, obsolescence or depletion except as expressly
permitted by this Part.
[18]
Bowman A.C.J. (as he then was)
explained the general approach to applying these provisions in International
Colin Energy. The first step is to determine whether the payment was made
for the purpose of producing income from a business or property. If it was,
then the second step is to ask whether the deduction is disallowed by paragraph
18(1)(b) because the payment was made on capital account. The final step is to
consider the application of provisions which permit the deduction of capital
expenditures, such as the paragraphs in subsection 20(1).
[19]
To classify a legal expense
following this procedure, the Court requires a description of the work done.
This description may not be privileged, as not all documents and information in
a solicitor’s possession are covered by solicitor-client privilege. For
example, where a lawyer has given business or investment advice, or where the
lawyer’s work consisted of unprivileged acts rather than advice, communication
related to that work is not protected. However, where a taxpayer seeks a
deduction for amounts incurred in respect of confidential legal advice, the
description of the work which the Court requires will be privileged.
[20]
The Appellant, like every
taxpayer, has the burden of proving the deductibility of its expenses, and it
is no answer to say, “that information is covered by solicitor-client
privilege”. There is no question that taxpayers have the right to keep
confidential all communications covered by solicitor-client privilege. However,
taxpayers who fail to provide adequate support to demonstrate the deductibility
of their expenses risk the denial of those deductions.
[21]
The question of what constitutes
adequate proof of the deductibility of legal expenses will depend on the facts
of each case. The Respondent suggested that I should be satisfied with nothing
less than the “specific legal advice” given by Olson Lemons to the
Appellant. I disagree. Adequate support to demonstrate the deductibility of
these expenses might take the form of a detailed invoice, an engagement letter,
or a reporting letter. Indeed, these documents might even be redacted to hide
some irrelevant detail and still contain enough information to allow the Court
to classify the expenses following the procedure described in International
Colin Energy. The Court will require descriptions of the tasks undertaken
by the lawyers, and the amounts charged for those tasks. In most cases, the
Court will not, and should not, require the Appellant to reveal items such as
complete legal advice memoranda, unexecuted drafts of contracts, or details of
its discussions with counsel in order to be satisfied that the amounts charged
by the lawyer are deductible business expenses.
If
the Appellant relies on privileged information to meet its onus, will an
implied waiver be found over its entire legal file?
[22]
The Respondent argues that the
Appellant has made its communications with Olson Lemons relevant to the issue
before the Court and it has thus waived solicitor-client privilege over those
communications. The Appellant, in the Respondent’s view, should not be allowed
to provide evidence as to certain aspects of its legal fees while using the
privilege to “deflect questions on the nature of the legal services and advice
provided necessary for the Minister to determine whether they are properly
deductible pursuant to the provisions of the Act.”
[23]
Given my finding that taxpayers
will often be required to reveal privileged information in order to claim
deductions for legal expenses, the effect of the Respondent’s argument is
profound: the Minister should have access to a taxpayer’s entire legal file in
order to evaluate that taxpayer’s claim for legal expenses.
[24]
In general, an implied waiver of
solicitor-client privilege is found where a litigant has voluntarily disclosed,
and sought to rely on, privileged communications. The concerns of fairness and
consistency operate to prevent litigants from relying on parts of privileged
communication while using the privilege to shield others.
[25]
The Supreme Court of Canada found
an implied waiver in R. v Campbell, which dealt with the legality of a “reverse sting”
operation. During the proceedings, the RCMP had relied on the fact that it
sought legal advice in arguing that the police had a good‑faith belief in
the legality of the operation. Binnie J., for a unanimous Supreme Court, found
that by supporting its good‑faith argument with undisclosed legal advice,
the RCMP had waived privilege over that advice.
[26]
In the context of litigation
before this Court, the Appellant has initiated the litigation by appealing its
assessment. Its Notice of Appeal raises the issue of its legal expenses.
However, if the Appellant is required to reveal privileged information, it is
forced to do so because of the Minister’s assumptions listed in the Reply to
the Notice of Appeal. Unlike Campbell, and other cases in which an implied
waiver has been found,
the Appellant in this context has no choice but to put its legal advice in
issue. In fact, the litigation arises because the Minister questions the nature
of that advice.
[27]
Moreover, fairness and consistency
would not operate to find an implied waiver in these circumstances. I accept
that, in general, it is problematic to allow a litigant to pick and choose the
privileged information to be disclosed. However, in this context it is both
fair and reasonable to expect a taxpayer to reveal enough information to
satisfy the Court and CRA as to the nature of the legal expense, while keeping
the specifics of the lawyer’s advice confidential.
[28]
To find otherwise would create an
unreasonable and unacceptable rule. Taxpayers would effectively have the choice
of foregoing a proper deduction for legal expenses or revealing to CRA the
entirety of their lawyer’s files. Such a rule would be inconsistent with the
status accorded to solicitor-client privilege as a substantive and fundamental
civil right, and a privilege which must be as close to absolute as possible.
Conclusion
[29]
When a taxpayer deducts an expense
from his or her income, he or she may be called upon to justify that deduction
– to convince the Minister, or failing that, the Court, that it is a properly
deductible expense. Where the expense is a lawyer’s fee, the proof that is
required will often be covered by solicitor-client privilege. While these Interim
Reasons are not intended to provide the CRA with a licence to access privileged
information, it is clear that a taxpayer who presents a claim for deductions in
a return must also accept that at least some disclosure will be necessary to
properly dispose of that claim.
[30]
However, to provide the proof that
is required, a taxpayer should not be forced to reveal the specifics of its
legal advice, or to turn over the lawyer’s entire file. In addition to limited
disclosure, the lawyer or the Court may edit documents to remove non-essential
material, and the Court may impose conditions to ensure the confidentiality of
the information. Further, taxpayers must be allowed to provide the proof that
is required without the risk that they will be found to have waived the
privilege entirely.
[31]
In light of the insufficient
evidence that was adduced, I am unable to reach a fair and just conclusion. As
a result of these Interim Reasons, the parties are directed to reconsider their
positions. Consequently, I direct that:
1) On or before June 15th, 2011, the Appellant
and lawyers from Olson Lemons shall meet to reconsider what information the
Appellant is willing to provide under a limited and partial waiver of
solicitor-client privilege in accordance with these Interim Reasons.
2) On or before July 31st, 2011, a
representative of the Respondent shall attend at the offices of Olsen Lemons in
Calgary to review the information that the Appellant is willing to provide.
3) On or before August 31st, 2011, both parties
shall report back to the Court in writing.
Signed at Ottawa, Canada, this 15th day of April 2011.
“Diane Campbell”
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