24 May 2018 CTF Seminar - Preventing, Navigating, and Resolving Tax Disputes
This summarizes oral remarks made by CRA representatives during the Canadian Tax Foundation Seminar "Preventing, Navigating, and Resolving Tax Disputes." The Panel was held on 24 May 2018 in Montreal. The two summaries below are of CRA comments made in two panels: "Challenges of an Evolving Tax Landscape"; and "Managing Tax Risk, The Ins and Outs of Reporting and Compliance."
Challenges of an Evolving Tax Landscape
The CRA presenter was Ted Gallivan, Assistant Commissioner, International, Large Business and Investigations Branch.
Q.1 – Global Tax Landscape
Tax Fairness and the Political Landscape
The first point to address is where the societal drivers for “tax fairness” are coming from. Globally, there is a real sense of income inequality, and taxation is seen as the preeminent policy sphere to address that inequality. Elected officials pick up on that. At G7 and G20 meetings, this idea of income inequality is on the agenda. The OECD, providing secretariat services, continues to develop measures to either reassure the public or to make tangible changes.
To give you some insight into the tax fairness camp, there are advocacy groups that look at the something like the tax-free savings account, or the principal residence deduction for capital gains, as a wholly unfair tax advantage, because 50%-80% of Canadians will have no hope of ever taking advantage of that. Those advocacy groups talk to the elected officials, and the elected officials then come to people like me and say “what are we going to do about it?” (Of course, like many family discussions, the “we” really means “you.”)
Those are the drivers. As senior officials in the government, we have to tease out what that means for Canada today. You can see that in the tightening of the voluntary disclosure program. There are some stakeholders and elected officials who would have preferred to scrap the program entirely. We have to be sensitive to the needs of society, but also develop reasonable public policy. Thus, from our perspective, a tightening of the VDP was a reasonable response.
Similarly, you might have heard about budget increases for CRA. That was ramped up over multiple years, and was not so much about more auditors as for better technology and tools for targeting and risk-assessment. There is certainly political and social pressure for more CRA audits, but then we need to figure out the best response to that legitimate pressure that does not collapse the audit system.
Fairness plays out within countries, but also between them. The OECD has many developing nations in it. Like a Canadian saying “I have no hope of ever having the cash-flow for a TFSA,” they see multinationals operating into their country, yet people have no food. These are the kinds of problems that need evaluating.
Differentiating the Aggressive and Compliant Taxpayers
So what has changed for us? I think we are feeling that we need to differentiate the CRA tax experience with taxpayers. There is a certainty agenda – small businesses are the engines of growth and hiring, and multinationals boost GDP, so predictability for them is important. We need to better reward good behaviour – exchanges of rulings, faster Mutual Agreement Procedure, and so forth. The tax authority is feeling committed to offering a path to certainty.
By the same token, to those who stubbornly or aggressively fail to comply, we are to show no quarter. We are to make more referrals to Criminal Investigations.
For those of us who are accustomed to letting the facts and law drive our decisions, we are increasingly feeling pressure to use our professional judgment to differentiate people’s experience. That raises the question of, for example, how many tax years we go back in our audits. Broadly speaking, taxpayers who are generally compliant and cooperative during the audit process should receive some consideration around materiality of the scope, and the number of tax years looked at. Conversely, “repeat customers” with continually aggressive positions should see broader scope and more tax years in play.
Within our large audit program, we will sometimes assign an entire second team to taxpayers who continue to be high-risk.
Improved Detection of Non-Compliance
Since 2013, we have made more than 20 changes to improve our ability to detect non-compliance. In addition to country-by-country reporting, we now have the IT systems to manage and manipulate that information, and the human capacity to put 400 hours into refining the data. Since January 2015, we have received monthly data about electronic transfers exceeding $10,000, and we are mining that to identify areas of concern.
We have a paid informant program, and we are bringing lawyers into our investigations program to give us insights from the beginning. The Department of Finance has been good at closing loopholes. We will be exchanging CRS data with around 60 countries. We are second-wave adopters, so a lot of the bugs in that system have been worked out. We have received additional funds, and some of that has gone to auditors.
What this amounts to is a tax authority with more data than ever before, including the unnamed persons requirements. We are building IT systems to handle that data responsibly, so as to target only taxpayers that truly are the highest risk. We also increasingly have the tools to act on taxpayers who continually take aggressive positions .
Q.2 Trends in the Volume of Tax Disputes
Timely resolution of disputes
We are doing everything we can to reduce the volume of disputes. Tax disputes with other countries would typically increase, but Canada leads the Large Business network for the OECD’s Forum on Tax Administration, which involves tax commissioners from around the world. Canada has lead the “Knowledge-Sharing Platform,” which is basically “the Internet for tax authorities.” We have lead the Responsible Use of Country-by-Country Reports. Canada is playing a significant leadership and development role in developing worldwide standards and practical tools that would help minimize or mitigate tax disputes.
Of course, disputes will still happen – just look at the Trump tax-reforms in the US. Again, Canada leads the world in the Mutual Agreement Procedure. We are the only jurisdiction in the world that has met the timeliness standard of two years – we average about 21 months right now, and are committed to cutting that time even further. We are also on our game for US-Canada tax disputes.
Headquarters Direction of Audit Teams
CRA has decided to adopt mandatory referrals from auditors to Headquarters. For a long time, audit teams had the discretion to refer to Headquarters if they felt they needed help or advice. We have decided that is too soft. There were too many files where we were brought in too late in the process – now, Headquarters will be reaching out and bringing in those files.
In addition to auditors, we also bring in Legislative Policy and Regulatory Affairs, and experts from Finance and Justice. We also try to bring in Appeals, although they of course want to preserve their independence.
We have also set aside $2.5 million this year for litigation advice at the audit stage. We understand the difference between legal advice and litigation advice, and we will increasingly be putting litigator eyes on the files at the proposal letter stage. CRA has this concept of a “decent proposal”, which is a proposal letter that we can stand behind – not just a proposal letter that floats gross negligence just to have something to concede to the taxpayer, but a real proposal, that stands the weight of, not just the CRA’s view, but increasingly of Justice and Finance when the amounts are material.
We are seized of our obligation and responsibility, in the audit function, to prevent disputes cheaply, before they actually begin.
[Answering a question, Ted Gallivan further noted that CRA does not intend to “hide behind” solicitor-client privilege, arising from the litigation advice, in order to make the audit process less transparent. On the contrary, the vision is to make the entire audit-report available to the taxpayer.]
[Answering the question about what criteria should be used to decide whether to involve litigation advice, Ted Gallivan indicated:]
When we talk about FATCA, or CRS, or CbC reporting, that’s all information that we could have had anyway on request, but we’re getting it automatically. It’s the same thing with the litigators – it’s something that auditor teams can have on request.
The shift we’re making is that Headquarters will be looking at all the files, and making its own recommendations about litigation advice or, as another possibility, a litigator needs to sign off on every reassessment over $5 million. It’s the mandatory-ness that will be different.
The underlying problem is that litigation advice was sought inconsistently across different audit teams.
Likely Areas for Tax Disputes
There are three areas where I think there might be trouble for the taxpayer.
I think access is still unresolved. Section 231 of the Act is very broad. The Minister can request “any” document, a provision that cries out for judicial review. We are revising our procedures about how the Large Business Program and International Program will use and request information. I think we are committing to being systemic and consistent, and to explain why we need information. This is an area of unsettled law, where the actual wording of the Act invites this broad approach, and CRA is implicitly compelled to act responsibly.
If you are the first person to try an innovative plan or structure, you would stand at a higher risk for litigation and tax audits. Regarding the abovementioned Headquarters involvement, one of the things we want is to understand emerging plans or structures, to canvas a lot of views on them, and have a case to bring forward. This does not necessarily mean leading with the first case in the country, but more often picking the most aggressive implementation of the new plan or structure, where we have the best evidence. We would seek to work that through the system, in order to lay out the limits of acceptable tax-planning from the top down.
Finally, a taxpayer’s compliance history would typically be measured in terms of the amount the taxpayer seeks to avoid in proportion to the amount voluntarily paid – a taxpayer who avoids $1 million in taxes but pays $2 billion is clearly different than a taxpayer who avoids $1 million and pays none at all.
In summary, CRA is committed to adopting the tools and practices to resolve tax disputes at the proposal letter stage where possible, and you should be aware of those three areas where there could be tax disputes.
Managing Tax Risk, The Ins and Outs of Reporting and Compliance
The CRA presenter was Gordon Parr, Director, Large Business Audit Division, International and Large Business Directorate, Compliance Programs Branch.
These notes also cover some questions asked by the other two presenters, Salvatore Mirandola (McCarthy Tétrault) and Michael O’Connor (Sun Life Financial).
Managing Tax Risks
Background to Risk Assessment
First, some background on the risk assessment process within the Large Business Audit Program. The CRA uses an integrated risk-based Approach to Large Business Compliance to identify and address the highest-risk cases nationally. The approach allows the CRA to focus its resources on the highest risk cases for non-compliance in the large business population and reduce the compliance burden for businesses that are considered low-risk.
Taxpayers who do not engage in abusive transactions. maintain an effective tax control framework. and are open and transparent with the CRA, are considered low-risk. The CRA’s objective is to ensure that large business taxpayers comply with the Income Tax Act. Taxpayers are entitled to plan their tax affairs to pay the least amount of tax allowable under the ITA and Regulations. Those that push the envelope and engage in abusive tax avoidance, for example, are considered higher-risk from a non-compliance perspective.
Our focus is to ensure that taxable income is not significantly understated, and that tax pool balances are not significantly overstated, through effective compliance activities. Those are good indicators of tax risk. To the extent that the CRA is able to validate, based on sufficient audit evidence, that the risk of non-compliance is low, the CRA will be in a position to close the particular audit and provide earlier tax certainty for the taxpayer.
In the case where there is a lack of sufficient appropriate audited evidence and the risk of non-compliance remains high, the CRA will take additional steps to examine these underlying tax risks to ensure that the taxpayer has reported and paid the correct amount of tax. This, however, may increase the level of tax compliance burden and tax uncertainty for those who remain high-risk and less cooperative. If it is determined that the taxpayer has understated taxable income or overstated a tax pool balance based on balance probabilities, the CRA will reassess the taxpayer for the required additional amount to ensure compliance.
Process re High-Risk Taxpayers
I am going to briefly cover our structure within Large Business Audit and how we do risk assessment. We have integrated large business audit teams lead by the international large business case manager. These teams reinforce the CRA’s team approach to compliance, so the domestic, international, and abusive tax-avoidance auditors within the teams all contribute to the risk assessment and audit process based upon their respective subject matter expertise.
The case manager is responsible for the overall audit case, and that acts as a single point of contact, so there is a service element there, between the CRA and the taxpayer, which is meant to support the concept of “one team, one voice, one audit”. The assignment of the workload and the composition of the integrated teams is based on risk, complexity and capacity.
The CRA uses a risk-based approach to large business compliance to identify and address highest risk cases nationally. On an annual basis, the large business population is subject to a comprehensive integrated risk-assessment process using the CRA’s Integrated Risk Assessment System. This automated system applies risk algorithms that are run on the CRA’s databases to identify risk issues and generate a risk-ranking of the large business population. This is known as our Tier 1 Risk Assessment Process.
The Tier 1 risk issues are then prepopulated in the screening case within the CRA’s audit case management system for those taxpayers that are considered to be highest risk. These screening cases are then assigned to the integrated teams for further analysis. At this Tier 2 stage, the case managers and the auditors will add their local and regional knowledge to the risk identified in Tier 1 to generate a risk profile for each taxpayer, as “high,” “medium,” or “low.” The highest risk taxpayers’ cases form the basis of the regional and national work plan. Those taxpayers who are considered high-risk per the work plan will then be selected for a full compliance audit starting what we call a Tier 3 Risk Assessment and Validation Stage.
The integrated team will contact the taxpayer, conduct the audit planning and governance document review process. The integrated team will take into consideration whether the taxpayer has an effective tax control framework. Taxpayers who are open and transparent about their tax risks and uncertain tax positions will enable the integrated teams to more quickly determine whether the taxpayer remains high risk or is in fact low risk. If the evidence says the taxpayer is low risk, the Tier 3 case will be closed, thereby providing the taxpayer with earlier tax certainty and the CRA with a level of assurance that the taxpayer is compliant and has paid the correct amount of tax.
For those taxpayers who remain high risk and less than transparent about their tax risks and uncertain tax positions, the CRA will proceed with a full compliance audit. In some cases, depending on the number of high-risk legal entities within the economic group and/or lack of cooperation by the taxpayer, we could allocate a second integrated team to examine other high-risk legal entities within the group to ensure compliance. This may increase the level of compliance burden and tax uncertainty for that particular taxpayer. The CRA will communicate to the taxpayer the significant audit issues in the case and reasons for assigning more resources if applicable. This may take place during an Approach to Large Business Compliance ("ALBC") face-to-face meeting.
The CRA will continue to conduct the face-to-face ALBC meetings toward the conclusion of the audit of the highest risk and least cooperative taxpayers to communicate to the entity’s senior management the unresolved compliance issues and, where they exist, the lack of openness and transparency. These face-to-face meetings will be used to achieve more compliant behaviour from the highest risk and least cooperative taxpayers within the population. The CRA will continue to promote voluntary compliance by increasing transparency and strengthening mutual trust and cooperation with Canada’s largest business entities. The CRA’s overall objective is to promote voluntary and cooperative compliance.
Tax certainty is an important objective for large businesses, for tax administrations, and for the tax community overall. Given the ever-changing tax compliance environment, and in particular BEPS developments, large businesses have elevated the issue of tax uncertainty and its potential effect on economic growth and development. That has been reported by the G20, and OECD, and IMF.
Tax administrations have a wide range of measures that can assist in reducing tax uncertainty, including advance tax rulings, advance pricing arrangements, mutual agreement procedure, joint audit, simultaneous audit, and international collaboration.
With respect to country-by-country reporting, Canada is a participating country in the international compliance assurance program pilot, to conduct multilateral risk assessment on a number of MNEs regarding certain international risks. The overall objective is to develop common understanding of certain international risks, to share best practices for effective use of CbC reporting, and to provide more tax certainty where possible.
With respect to CRA’s (ALBC) approach to large business compliance, it is recognized that large businesses are seeking earlier tax certainty for their uncertain tax positions. As indicated, the objective of the large business audit function is to examine and validate the level of compliance, in order to obtain a level of assurance or justify trust that the taxpayer has reported and paid the correct amount of tax. To the extent that the taxpayer provides the required information to validate that the risk of non-compliance is in fact low, the CRA can close its audit more quickly. Through openness, transparency, cooperation, disclosure of uncertain tax positions, the CRA can more effectively validate the level of risk, thus reducing compliance burden in achieving earlier tax certainty for compliant and cooperative tax payers.
Tax Accrual Working Papers
General Authority for s. 231.1 Demands
Salvatore Mirandola – In the BP Canada decision, the Federal Court of Appeal held that the Canada Revenue Agency does not have a general and unrestricted right to access tax accrual working papers, and that taxpayers do not have the obligation to self-audit, but that there may still be some circumstances in which the Canada Revenue Agency can legitimately and legally ask for tax accrual working papers.
After the Federal Court of Appeal decision was released, the CRA announced that it was going to look at its policies regarding tax accrual working papers and make revisions to those policies. Can you provide an update?
Gordon Parr – Generally, CRA officials are entitled to request taxpayer information pursuant to the general examination powers found in the ITA and ETA. This general authority includes the power to examine not only the records and documents of the taxpayer under review, but also the records or documents of any other person that relate to the tax liability of the taxpayer, unless the documentation is subject to solicitor-client or litigation privilege.
The CRA’s general policy requires that an auditor should attempt to obtain the necessary information from the books and records of the taxpayer to ascertain and ensure that the risk of non-compliance is low. There are multiple sources of information, and tax accrual working papers being one of them. CRA officials are not in a position to make a blanket request for tax accrual working papers and any request should be relevant and well supported with respect to the outstanding tax issues.
Under IFRS, in recognizing and measuring the effect of tax uncertainties for financial reporting purposes, there is a fundamental assumption that the tax authority will examine the tax-treatment of these uncertainties and have full knowledge of related information when making those examinations. Hence, access to tax accrual working papers may be necessary in certain cases in determining whether these tax positions, as reported in the taxpayer’s tax return, are in fact allowable under the Act.
We are looking at an informal consultation process, probably starting in the next three or four weeks. We will give external stakeholders an ability to provide comments on a draft internal communiqué.
As previously communicated, the CRA considers the facts and circumstances in the BP Canada case to be unique. Rather than appealing the Federal Court of Appeal decision, the CRA is addressing the issue on a broader scale by updating its audit procedures to clarify when and why information is to be requested from taxpayers. The CRA has also struck an access working group to support the CRA’s ability to request information and coordinate related litigation on a national basis. This working group continues to focus its attention on information sought by the CRA in activities related to administration and enforcement legislation.
Draft Internal Communiqué
Gordon Parr - As mentioned, we are currently updating the internal communiqué with respect to obtaining information from taxpayers, registrants and third parties. The communiqué will outline that CRA officials can seek the production of tax accrual working papers, provided that the request for such records is relevant to a specific risk issue or item under audit and the CRA official is using a certain level of restraint in seeking this information.
Tax accrual working papers may be sought where there are identified unresolved tax issues and there is a higher risk of non-compliance. Factors that may be considered include the level of non-compliance, large unexplained tax reserves, and potential tax at risk. The taxpayer may claim that the tax accrual working papers include information that is subject to solicitor-client privilege. The CRA cannot compel production of privileged communications. The taxpayer’s list of uncertain tax positions that relates to tax reserves in the taxpayer’s financial statements is considered to be part of the taxpayer’s books and records and is not a privileged document unless otherwise demonstrated.
CRA officials are expected to be objective when reviewing any information or documentation obtained during examination, rather than be influenced by the comments or opinions contained in the documentation reviewed. While CRA officials may, in certain circumstances, request the list of what the taxpayer has determined to be its uncertain tax positions, in considering the structures and transactions outlined, CRA officials should perform their own research and analysis in forming the basis of any potential reassessment. Provided that all of the relevant facts of the transactions are included in their uncertain tax positions, exclusions of the advisors’ analysis of the legal and tax effects of the transactions may be considered.
Taxpayers are encouraged to maintain openness, transparency and cooperation with CRA officials, and must clearly demonstrate, based on sufficient appropriate audit evidence, that the overall risk of non-compliance is in fact low. Taxpayer’s may voluntarily provide additional information such as tax planning documents and tax accrual working papers to the CRA to expedite the compliance activity and to achieve earlier tax certainty.
Michael O’Connor – Does that include drafts of working papers?
Gord Parr – Generally the final documents will suffice.